BASIC ENGINEERING ECONOMICS AACE INTERNATIONAL

calculations, these streams of money, or cash flows, can be Table 27.1—Cash Flow Table
converted to either lump-sum values at any point in time or
a series of uniform benefits/costs. The conversion of dissim- YEAR INCOME EXPENSE
ilar cash flows to similar lump-sums or uniform series at a 0 $20,000
particular interest rate and a common point in time provides 1 $5,000 500
values with a valid basis for comparison. 2 5,000 600
3 5,000 700
The model used for engineering economic analysis is based 4 5,000 800
on the conversion of an existing cash flow to an equivalent 5 5,000 900
cash flow at a particular interest rate through the application
of predefined factors. The cash flow can be represented in
tabular or graphical format. The conversion factors are called $5,000 $5,000 $5,000 $5,000 $5,000
discount factors and are readily available in either algebraic
form or in tables. Many hand-held calculators have been pro-
grammed with these factors in addition to most computer 0 1 2 3 4 5
spreadsheet applications. A thorough understanding of the
structure and development of the model and its components
will permit the solution of engineering economic problems $500
$600 $700 $800
using any of three approaches: tabular, calculator, or com- $900
puter spreadsheet application.

CONVENTIONS $20,000

Cash Flow Representation—Cash flow occurs whenever
cash or something of monetary value flows from one party to
another. It can be either cash flow in, for example cash
receipts, or when payments or disbursements are made,
which is a cash flow out. This can be shown in a tabular for-
mat as in Table 27.1 or in the case of relatively simple prob-
lems, a cash flow diagram similar to figure 27.1(a) can be
developed. The cash flow diagram consists of two basic
parts: (1) the horizontal or time line, and (2) the vertical
arrows or cash flow lines. The horizontal line is divided into
periods appropriate for the specific problem under consider-
ation. Each vertical line represents an interest period based
on an end of period convention. Thus, the points in Figure
27.1(b) represent interest periods 1 through 5. These periods
could be daily, monthly, quarterly, semi-annually, or annual-
ly depending on the problem statement. All transactions will
be assumed to occur at the end of the interest period.
The vertical lines represent cash flow and are placed accord-
ing to the timing and direction of the cash flow. Receipts or
income are represented by an upward arrow, while disburse-
ments and expenditures are downward arrows representing
cash out. Although the arrows are not usually to scale, a
longer line will distinguish a large cash flow from a smaller
one. The arrows also will be labeled with the monetary value
of the transaction. Other labels that might be used on arrows
are P, A, F, G, and S, as shown in Figure 27.1(c). These terms
have been previously defined in the list of symbols.
Figure 27.1(a)—Cash Flow Diagram
Income/Benefits/Receipts/Salvage
1 2 3 4
0 5
Cost/Expenditures/Disbursements
Figure 27.1(b)—Cash Flow Convention
Salvage Value—In many studies there may be a residual
value resulting in income at the end of the useful life of an
alternative. The resale or salvage value may be associated
with the anticipated market value of the asset at that point in
time. It is shown as an upward arrow on the cash flow dia-
gram. If the salvage value is low with respect to other cash
flow, it is usually omitted. Any significant costs associated
with disposal at the end of useful life also can be shown on
the diagram as a downward arrow.
INTEREST
Time Value of Money—When monetary consequences of a
problem occur over a substantial period of time there is usu-
ally a cost associated with the use of the money. Since money
is a valuable asset, people are willing to pay to have it avail-
able for their use. This could be likened to paying rent for the
use of money just as one would pay rent for the use of an
apartment. With money, the charge for its use is called inter-
est rather than rent.

27.2