Time Value of

Money
Engineering Economic
Annisa Uswatun Khasanah

1
 Introduction
• When making decision in choosing the
best alternatives, time is one important
factor that must be considered.
• There will be economic consequences if
the alternatives are taken immediately
(right away), in a short period or in a long
period.
• Money consequences of any alternative
occur over a substantial period of time –
time value of money
2
 Introduction
• The idea that money available at the
present time is worth more than the same
amount in the future due to its potential
earning capacity.
• The time value of money explains the
change in the amount of money over time
for funds that are owned (invested) or
owed (borrowed).
• This is the most important concept in
engineering economy.
3
Time value of money concept
• You have won a cash prize! You have two
payment options: A - Receive $10,000
now OR B - Receive $10,000 in three
years. Which option would you choose?

4
Time value of money concept
• For option A: by receiving $10,000 today,
you are poised to increase the future
value of your money by investing and
gaining interest over a period of time.
• For Option B, you don't have time on your
side, and the payment received in three
years would be your future value

5
Time value of money concept

• If you are choosing Option A, your future

value will be $10,000 plus any interest
acquired over the three years.
• The future value for Option B, on the other
hand, would only be $10,000. 6
 Interest Concept
• Interest is the manifestation of the time
value of money.
• Interest is the difference between an
ending amount of money and the
beginning amount. If the difference is zero
or negative, there is no interest.
• There are always two perspectives to an
amount of interest— interest paid and
interest earned.
7
Interest Concept

8
 Interest Concept
• Interest is paid when a person or organization
borrowed money (obtained a loan) and repays a
larger amount over time.
• Interest paid on borrowed funds (a loan) is
determined using the original amount, also
called the principal. Equation 1.1

Interest = amount owed now - principal

9
 Interest Concept
• Interest is earned when a person or organization
saved, invested, or lent money and obtains a
return of a larger amount over time.
• interest paid over a specific time unit is
expressed as a percentage of the principal, the
result is called the interest rate. Equation 1.2

10
Interest Concept

11
 Terminology and Symbol
P = value or amount of money at a time designated as the present or
time 0. Also P is referred to as present worth (PW), present value
(PV), net present value (NPV), discounted cash flow (DCF), and
capitalized cost (CC); monetary units, such as dollars
F = value or amount of money at some future time. Also F is called
future worth (FW) and future value (FV); dollars
A = series of consecutive, equal, end-of-period amounts of money. Also
A is called the annual worth (AW) and equivalent uniform annual
worth (EUAW); dollars per year, euros per month
n = number of interest periods (The time unit of the rate); years,
months, days
i = interest rate per time period; percent per year, percent per month

12
Example
• You plan to make a lump-sum deposit of
$5000 now into an investment account
that pays 6% per year, and you plan to
withdraw an equal end-of-year amount of
$1000 for 5 years, starting next year. At
the end of the sixth year, you plan to close
your account by withdrawing the remaining
money. Define the engineering economy
symbols involved.
13
Example
• All five symbols are present, but the future
value in year 6 is the unknown.
– P = $5000
– A = $1000 per year for 5 years
– F = ? at end of year 6
– i = 6% per year
– n = 5 years for the A series and 6 for the F
value

14
 Cash Flow
• Cash flows are the amounts of money estimated for
future projects or observed for project events that have
taken place.
• Cash inflows are the receipts, revenues, incomes, and
savings generated by project and business activity
• Cash outflows are costs, disbursements, expenses, and
taxes caused by projects and business Cash flow
activity. A negative or minus sign indicates a cash
outflow.

R is receipts, and D is disbursements 15

 Cash Flow
Cash inflows

(time)

Cash outflows

16
 Interest Concept
1. Simple interest
2. Compound interest

17
 Simple Interest
• Simple interest is calculated using the
principal only, ignoring any interest
accrued in preceding interest periods

F = P(1+i.n)
F = P + Pni
F=P+I

18
Simple Interest - Example
• Green Tree Financing lent an engineering
company $100,000 to retrofit an
environmentally unfriendly building. The
loan is for 3 years at 10% per year simple
interest. How much money will the firm
repay at the end of 3 years?
– P = $ 100,000
– n = 3 years
– i = 0,1 per year
19
Simple Interest - Example
The interest for each of the 3 years is:
Interest per year = ($100,000)(0.10) = $10,000

Total interest for 3 years from is:

Total interest (I) =Pni
Total interest (I) = ($100,000)(3)(0.10) = $30,000

The amount due after 3 years is

Total due (F) =P+I
Total due (F) = $100,000 + 30,000 = $130,000
20
 Simple Interest - Example

F = P(1+ i .n )
= $100,000 [1 + (0,1 x 3)]
= $130,000

21
Simple Interest - Example

Amount Amount
Year Principal Interest
owned paid
0 100,000 0 100,000 0
1 10,000 110,000 0
2 10,000 120,000 0
3 10,000 130,000 130,000
P = 100,000

i = 10%
n=3 F = 130,000 22
 Compound Interest
• the interest accrued for each interest period is
calculated on the principal plus the total amount
of interest accumulated in all previous periods.
• Compound interest reflects the effect of the time
value of money on the interest also

23
Compound Interest - Example
• Assume an engineering company borrows
$100,000 at 10% per year compound
interest and will pay the principal and all
the interest after 3 years. Compute the
annual interest and total amount due after
3 years.
– P = $ 100,000
– n = 3 years
– i = 0,1 per year
24
Compound Interest - Example
Interest, year 1: 100,000(0.10) = $10,000
Total due, year 1: 100,000 + 10,000 = $110,000
Interest, year 2: 110,000(0.10) = $11,000
Total due, year 2: 110,000 + 11,000 = $121,000
Interest, year 3: 121,000(0.10) = $12,100
Total due, year 3: 121,000 + 12,100 = $133,100

Or follow P(1+i)n
Year 1: $100,000(1+ 0,10) 1 = $110,000
Year 2: $100,000(1+ 0,10) 2 = $121,000
Year 3: $100,000(1+ 0,10) 3 = $133,100
25
Compound Interest - Example
Amount Amount
Year Principal Interest
owned paid
0 100,000 0 100,000 0
1 10,000 110,000 0
2 11,000 121,000 0
3 12,100 133,100 133,100
P = 100,000

i = 10%
n=3 F = 133,100

26
The difference between Simple and Compound Interest

$133,100 – 130,000 = $3100

27
 Single Payment Compound
Factor
single payments; they are used to find the
present or future amount when only one payment or
receipt is involved.

28
Uniform Formula

29
Uniform formula- Example
• How much money should you be willing to pay now for a
guaranteed $600 per year for 9 years starting next year,
at a rate of return of 16% per year?
– A = $600 A = $600

– n = 9 years 0 1 2 3 4 5 6 7 8 9

– i = 16 %
– P=?
P=?

P = $2763.93
30
 Uniform formula- Example
• The president of Ford Motor Company wants to know the
equivalent future worth of a $1000 capital investment
each year for 8 years, starting 1 year from now. Ford
capital earns at a rate of 14% per year.
– A = $ 1000
– n = 8 years
– i = 14%
– F=?

F = $13,232.80
31
Exercises (assignment 4)
1. A man deposit $500 in a credit union at the end of each
year for five years. The credit union pays 5%
compounded annually. At the end of five years,
immediately following his fifth deposit, how much will he
have in his account?
2. On January 1, a man deposits $5000 in acredit union
that pays 8% interest compounded annually. He wishes
to withdrawal all the money in five equal end of year
sum, beginning December 31st of the first year. How
should he withdraw each year?

32
Exercises
3. If $500 were deposited in a bank saving
account, how much would be in the
account three years hence if the bank
paid 6% interest compounded annually?
4. If you wish to have $800 in a saving
account at the end of four years, and 5%
interest compound was paid annually,
how much should you put into the savings
account now?
33
Exercises
5. Iselt Welding has extra funds to invest for
future capital expansion. If the selected
investment pays simple interest, what
interest rate would be required for the
amount to grow from $60,000 to $90,000
in 5 years?

34
Exercises
6. A solid waste disposal company
borrowed money at 10% per year interest
to purchase new haulers and other
equipment needed at the company owned
landfill site. If the company got the loan 2
years ago and paid it off with a single
payment of $4,600,000, what was the
principal amount P of the loan?

35
7.Perhatikan diagram alir kas tersebut jika tingkat bunga adalah 12%,
hitunglah P, F pada akhir tahun ke 5 dan A! (untuk menghitung nilai
P, tariklah semua nilai menjadi nilai P terlebih dahulu, kemudian
tambahkan dengan Rp 6000. Baru hitung F dan A)
8.Banyaknya uang yang harus ditabungkan mulai tahun depan
selama 6 tahun berturut-turut dalam jumlah yang sama agar pada
akhir tahun ke 10, uang yang terkumpul sebesar Rp 20 juta, jika i =
10%/tahun adalah?
9. Banyaknya uang yang akan diperoleh
10 tahun yang akan datang, jika mulai
tahun depan selama 5 tahun
berturut-turut ditabungkan uang
sebanyak Rp 20 juta/tahun pada tingkat
bunga 10%/tahun adalah?