TIME VALUE OF MONEY:Time value of money means that two equal amount at different point of time do not have

equal value If the interest rate is greater than zero. It is the relationship between interest and time that leads to the concept of time value of money. Example:1. Simple interest 2. Compound interest Where P= present worth i= annual interest rate n = no. of year F= future worth ,

CASE FLOW DIAGRAM:The use of cash flow diagram is strongly recommended for situation in which the analyst needs to visualize what is involved When flow of money occurs at various times. So the graphical representation of each value plotted at appropriate time is called Cash Flow Diagram. The normal conventions for cash flow diagram as follows-

1. The horizontal line is a time scale with progression of time moving from left to right. 2. The arrows signify cash flow, normally downward arrows represent the out flow cost or disbursement and upward arrows represent the benefits or receipts.

INTEREST FORMULAE FOR SINGLE PAYMENT SERIES:-

Case 1:1 2 3 4 5 n-1 n

Finding F, when given P

Where F = Future worth at end of n years P = present worth at 0 time i = Interest rate in decimal n = no. of years

Case 2:-

A1

A2

A3

A4

An-1

An

n-1

Finding P, when given F

= Single payment present worth factor = (P/F, i, n) Hence P = F (P/F, i, n).

INTEREST FORMULAE FOR EQUAL PAYMENT SERIES:-

Case 3:- Finding P, when given A.

From the G.P., Sum of payment =

[ ]

The Bracket portion shows the equal payment series present worth factor using functional notations as (P/A, i, n). [ ]= equal payment series present worth factor = (P/A, i, n)

Hence P = A (P/A, i, n).

Case 4:- Finding A, when given P.

[ ]

The bracket portion shows the Capital recovery factor using functional notations as (A/P, i, n).

]= capital recovery factor = (A/P, i, n).

Hence A = P (A/P, i, n).

Case 5:- Finding F, when given A.

Substituting the value

= [ [

The bracket portion shows the equal payment series compound amount factor given by fundamental notations as (F/A, i, n).

] = equal payment series compound amount factor = (F/A, i, n).

Hence F = A (F/A, i, n).

Case 6:- Finding A, when given F.

The bracket portion shows the Sinking fund factor using functional notations as (A/F, i, n). = Sinking fund factor = (A/F, i, n). Hence A = F (A/F, i, n).

INTEREST FORMULAE FOR UNIFORM GRADIENT PAYMENT SERIES:(n-1)g 2g g 3g

A1

1 P

n-1

n F

The equivalent annual payment series

Ques. - Maintenance cost of a new bridge for an accepted 50 year like we estimated Rs10000 each year for first 5 year followed by an Rs100000 in 15th year and Rs100000 in 30th year. If i=10% per year. What is the equivalent uniform annual cost over the entire 50 year?
10000 10000 10000 100000 100000

15

30

= Rs67013.45
[ ]

Ques. - If a man receipts on annual salary of Rs80000/- increasing at the rate of Rs5000/- per year. What is the equivalent average salary for 10 year present worth and future rate of interest is 10%. Solution:-

By

Ques. - Certain operating expenditure were expected to be zero at the end of the first six month rate Rs1000 at the end of second six month and to increase by rate Rs1000 at the end of each six month period.Thereafter for a total of four year It is desired to find the equivalent uniform payment at the end of each 6 month period and its present worth of interest 20% Compounded semi-annual. Solution:-

2000 1000

3000 0

A1

1 P

8 F

METHODS OF ECONOMIC ANALYSIS 1. 2. 3. 4.

Present worth amount method

Annual equivalent amount method The capitalized amount method The rate of return method

1. PRESENT WORTH AMOUNT METHOD:The method is described as follows:1. Indicate all expenses and benefit at appropriate point of time in the form of cash flow separately for each alternative. Represent downward arrow for expenses (cost) and upward arrow for benefits or savings. In the algebraic expression + sign for expense and ve sign for benefit. 2. Shift the amount at zero time by using proper interest formula and find total present worth amount of each alternative and compare. There may be two cases. CASE 1. When service life of each alternative is same item no. (ii) will clearly indicate which alternative has lower present worth. The alternative having lower present worth is economically accepted. CASE II. When service life of alternative is different. The cycle of item no. (ii) is repeated till the common service life is obtained. The common life is taken as L.C.M. value of given life. The overall present worth of alternative are obtained and then compared for the selection of the economical alternative.

2. ANNUAL EQUIVALENT AMOUNT METHOD:The annual equivalent amount is another basis for comparison that has characteristics similar to present worth method. The cash flow is converted into a series of equal amount by first calculating the present worth amount for the original series

and then multiplying it with capital recovery factor ( by seeing the annual equivalent amount of each alternative.

). The comparison is made

3. THE CAPITALIZED AMOUNT METHOD:The annual equivalent amount is assumed to extend for infinite period and the capitalized amount is obtained by using . The equivalent annual amount is calculated for replacement and maintenance cost and added to the initial cost of the alternative.

4. THE RATE OF RETURN METHOD:It is defined as the interest rate that reduces the worth amount series of receives and disbursements to zero for each alternative. In economic terms, the fundamental concept of rate of return is that it is the rate of interest earn on the unrecovered balance of an investments so that the uncovered balance is zero at end of investments life. The computation of rate of return generally require a trial and error solution until the i* can be interpolated. The common convention used is + sign for cash inflows and - signs for cash outflows. Exercise: The two machine A & B have the following cost with money worth as 8 % per year. Description
First cost

Salvage value Uniform and of year expenditure Irregular expenses end of first year Irregular expenditure at end of third year

Machine A Rs10000 Rs1100 Rs3000 Rs1000 Nil

Machine B Rs25000 Rs1500 Rs2000 Nil Rs2500

Benefit from quality control(at end of year) Life

Nil 2 year

Rs600 5 year

Compare the machine for the following basis: a) Present worth method b) Equivalent annual cost worth method c) Capitalized amount method Solution: cash flow diagram for machine A

1100

10000

3000

3000

Cash flow diagram for machine B

600 600 600 600 600 + 1500

25000

2000

2000

2000 +2500

2000

2000

Present worth of A
P2 = [ ] [ ] [ ]

=Rs15352 Present worth of B P5 = = Rs31543 i) PRESENT WORTH METHOD:Present worth value for common life period L.C.M. of their lives=10 year PA(10) =
[ ] [ ] [ ] [ ]

= Rs57802 PB(10) = [ ]

= Rs53043 Since PB(10) < PA(10) so machine B is selected.

ii) EQUIVALENT ANNUAL WORTH METHOD:AA = equivalent annual worth of machine A = [ ] = Rs8600

AB = equivalent annual worth of machine B

] = Rs7900

Since A(B) < A(A) so machine B is selected.

iii) CAPITALIZED COST METHOD:C(A) = capitalized worth of machine A = (equivalent annual worth of machine A)/i = 8600/0.08 = Rs107500 C(B) = 7900/0.08 = Rs98750 Since CB < CA so machine B is selected.

Depreciation:It is the decrease in value of asset resulting from deterioration, weir & tear from you, obsolescence arising from improvement in design & new technology. Depreciation of asset makes them less able to render the service for which it was originally made. In making allowances for depreciation of this nature in the engineering economy study the object is to distribute the initial cost of the asset for less salvage value over the period of its life. For estimation of current market value of equipment at that year, this is book value. 1. Allocating the depreciation portion of equipment ownership cost over a period of a time and calculation of production cost of the good. 2. Tax benefits. Types of depreciation:i) Physical depreciation ii) Function depreciation iii) Contingent depreciation 1. Physical depreciation:Depreciation resulting in physical impairment of an asset is known as physical depreciation. The result in lowering the ability of the asset to render it intended service. The primary cause of physical depreciation is wear and tear because of its constant use such as abrasion, shocks, vibration, and impact etc. and the deterioration due to action of elements such as corrosion of pipe, chemical decomposition. 2. Function depreciation:Functional depreciation often called OBSOLESCENCE is defined as the loss in the value of the property due to change in fashion, design or structure due to inadequate to meet the growing demand, necessity of replacement due to new invention be more economical and more efficient etc..

3. CONTINGENT i. ii. iii.

DEPRECIATION:Accident(due to negligence) Diseases(pollution of water ,parasites) Diminution of supply (natural gas, electricity, water etc.)

Methods of depreciation accounting:1. Straight line method 2. Sum of the year method 3. Declining balance method 4. Sinking fund method 1. Straight line method :This is the easiest method to calculate depreciation & most widely used. The basis of method is that the difference between initial cost of asset and the estimate salvage value of the end of life is divided by the life in year to give the uniform instalment of depreciation in written of every year. Example:-Given: initial cost =Rs12000/- , salvage value =Rs2000/Life of equipment =5 year Depreciation= Year 0 1 2 3 4 5 = Depreciation 0 2000 2000 2000 2000 2000 =Rs2000 Book value 12000 10000 8000 6000 4000 2000

2. Sum of the year method:This is accelerated method i.e. a greater proportion of the initial cost of asset to be depreciated in the early period of its life. Each years depreciation of an asset is calculated as a fraction of total cost where there is no salvage value or of initial cost at low salvage value. The depreciation for any year of an asset may found from following relation. Depreciation (D) = [ ] P=initial cost L=salvage value n=total life of asset A=year number for which depreciation is required Year 0 1 2 3 4 4 Depreciation Rate Annual Depreciation 0 0 5/15 3333 4/15 2667 3/15 2000 2/15 1333 1/15 667 Book Value 12000 8667 6000 4000 2667 2000

3. Declining balance method:This method used to write the initial cost of the asset in the greater value for early year of life. In this method a fixed percentage of book value of an asset is written off annually. The ratio of the depreciation for any year to the book value of the asset at the beginning of that year is there constant for all year of the assets life. Note that the book value cant go below the salvage value despite the salvage value is not calculating.

The depreciation relation 1.25/n or 1.5/n or 1.75/n or 2/n is used. 2/n method is double declining method. Dn = R(BV)n Year Depreciation Book Value 0 0 12000 1 4800 7200 2 2820 4320 3 1728 2592 4 1037 2000 5 2000 4. Sinking fund method:This method sometimes called present worth method. Since the calculation of book value at any year may carried out by using discounting principle i.e. time value of money. The amount of annual deposit is so calculated that the accumulated sum at the end of estimated life of the asset and the started interest rate will just equal the value of the asset which is being appreciated. This value as before will be either the initial cost of the asset or if the asset has a salvage value the initial cost will less the salvage value. The amount of asset written out any one year is uniform payment + the interest charge for that year on the amount already accumulated in the sinking fund. Sinking fund factor = [ ]

Year 0 1 2 3 4 5

Depreciation Amount 0 1638 3438 5420 7200 -

Book Value 12000 10362 8152 6580 4800 2000

Graphical representation of all depreciation methods:14000 12000 10000 8000 6000 4000 2000 0 no. of years -> Straight line method sum of year method declinig balance method sinking fund method salvage value curve

Breakeven cost analysis:Breakeven cost analysis is a tool for studying the relationship between volume, cost, revenue and profit. It is helpful in profit planning, the profitability projections are essential to judge the financial desirability i.e. profitability of project.

Important term used in breakeven cost analysis

Fixed cost:Fixed cost is comprised of wages and salary, maintenance, rent, insurance, depreciation, administrative expenses and interest etc. Variable cost:Variable cost comprise of raw material, consumable item, power, fuel water and selling expenses etc.

ASSUMPTIONS:5. The cost can be divided into two categories (a). Fixed cost (b). Variable cost. 6. The unit selling price is constant, this means that total revenue varies linearly. 7. Inventory charges are nil. It means there are no storage of goods, it will produce and direct to sell. This method is known as the just in time method. 8. The total cost is equal to the sum of fixed cost and variable cost.

ANALYSIS:The analysis can be done in two ways (a).Graphical method. (b). Analytical method.

14 12 10 8 variable cost 6 4 2 0 output -> fixed cost

Graphical method:1. Draw the total cost curve between cost and production output. 2. Draw the revenue curve with the help of unit selling price of goods and production output. 3. Determine the cut-off point of the above two curve (total-cost curve & revenue curve).this cut-off point is the point at which the total cost of production is equal to the total output and have no benefit of production. Or it can be say that it is the point at which the producer starts gaining profit. This point is known as BREAK EVEN POINT.

BREAK EVEN POINT

variable cost fixed cost total cost revenu

output

->

ANALYTICAL METHOD:LET F= FIXED COST Q= QUANTITY PRODUCE TO SOLD V= UNIT VARIABLE COST P= UNIT SELLING PRICE PROFIT =output(unit selling price x quantity) input(variable cost+fixed cost) = QxP (QxV + F) =0

For breakeven point there would be no profit, so Breakeven production

Q=

Quantity for given profit:If

T

is the given profit, then Target quantity

QT =

Breakeven cells:Breakeven cells are defined as the multiplication of breakeven quantity to unit selling price.

Margin of safety:The horizontal line distance between BREAKEVEN POINT and output being produced is called margin of safety.

Angle of incidence:The angle between sale line and total cost line at BEP is called angle of incidence. Ques:- the fixed cost for the year 1994-95 are rupees 600000/-. The estimated sells for the period are Rs at 200000/- . The variable cost per unit for the single product made is Rs5/-. If each unit sell at Rs 25/- and the number of unit involved will coincide the expected value of output construct the break even chart..

Find:1. 2. 3. 4.

Break-even point. Profit earn as a turnover of 125000/Margin of safety Angle of incidence Solution:1. Breakeven Point (=0) Q= = =3000 2.

3. Margin of Safety = (Expected output- B.E.P.)/(Expected output) = 4. Angle of incidence:=slope of revenue curve slope of cost curve = Angle = [ ] = 12.5 12.5 = 4.57390