ENGR 3360U Winter 2014

Unit 6.4-6
AW of Permanents, Salvage and Mortgages
Dr. J. Michael Bennett, P. Eng., PMP,
UOIT,
Version 2014-I-01

Unit 6 Annual Cash Flow

Change Record
2014-I-01 Initial Creation

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Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 6 Annual Cash Flow

6.4 AW of a Permanent Investment

If an investment has no finite cycle (or a very long
estimated life) it is called a perpetual or permanent
investment
If P is the present worth of the cost of the investment,
then the AW value is P times i

AW =A = P(i)
AW is actually the amount of interest P would earn each year,
forever.
Remember: P = A/i
from the previous unit

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Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 6 Annual Cash Flow

Example 6.5
A road must get past a mountain. There are 2
options: tunnel through the mountain or build
a road around it supported by concrete pillars.
The cost for the tunnel is $5.5M and the
useful life is infinite. The road would cost
$5M but only last 50 years. Assume 6%.

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Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 6 Annual Cash Flow

Solution
Tunnel: A = Pi. So A = 5.5(0.06) = $330K
Road: A = 5(A/P,6%,50) = $317K
Select the road.

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Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 6 Annual Cash Flow

6.5 Salvage Value

When there is a salvage value at the end of
the life of an asset, it is represented as a
one-time cash flow benefit at the end of the
assets life.

Example: Salvage valueS (S) of asset with a

4 year life
0

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Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 6 Annual Cash Flow

Salvage Value, contd.

When there is an initial cost (P) followed by a salvage
value (S) the annual worth (AW) can be computed by:
AW = P(A/P, i, n) S(A/F, i, n)
OR
AW = (P S)(A/F, i, n) + Pi
OR
AW = (P S)(A/P, i, n) + Si

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Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 6 Annual Cash Flow

6.6 Mortgages in Canada

The legal document:

Long term amortized loan that is used for buying property

If payments are not made, the lender can seize the property
and sell it to recover the debt
Legal document outlines the terms and conditions for
repayment of the loan (amortization period, interest rate,
penalties, etc.)

Amortization:

Length of time it takes to pay off loan assuming:

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Payments are made on time with no additional payments

Interest rate doesnt change

2014-I-01

Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 6 Annual Cash Flow

Mortgages in Canada
Amortization periods are typically between:

5 years to 35 years
The norm is 20 or 25 years

Terms

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A mortgage is often made up of smaller periods

called terms and a term is the period in which
the interest rate term is fixed.
At the end of the term, the mortgage can be
renewed for a another term at the current interest
rate.

2014-I-01

Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 6 Annual Cash Flow

Types of Mortgages
Conventional:

For 75% or less of the appraised value

High-ratio mortgages:

Higher than 75% and usually require an outside

agency such as the CMHC (Central Mortgage
and Housing Corporation) to insure the mortgage.

Some Others:

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Open, variable rate, ARM, capped rate,

convertible rate, second, reverse, and CHIP.

2014-I-01

Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 6 Annual Cash Flow

Mortgage Equity and Interest Rates

Equity

The value remaining in a property after all mortgage and

loans registered against the title are subtracted from its
value.

Interest Rate

Interest rate is expressed as:

% compounded semi-annually, not in advance

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An old English term when ledgers were kept by hand

Nominal rate mortgage at 6% is actually 3% semi-annually

Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 6 Annual Cash Flow

Summary
Unlike present worth analysis, annual cash
flow analysis does NOT require a common
analysis period between the alternatives.
However two assumptions are included:

That the actual values of future instances of a

service are the same as the current instance
There is a common multiple of useful lives
between the alternatives

As the value of n increases the capital recovery

factor approaches i.
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Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 6 Annual Cash Flow

Summary, contd.
Mortgages in Canada are amortized over a
number of years.
There are a number of types of mortgages.
Equity:

The appraised property value value of

mortgage owing

Interest rate is traditionally stated as:

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% compounded semi-annually, not in advance

2014-I-01

Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 6 Annual Cash Flow

Chapter Summary cont.

AW method is often preferred to the PW method
AW deals with only one life cycle of an alternative
AW offers an advantage for comparing different-life
alternatives
Assumption for AW method: Cash flows in one
cycle are assumed to replicate themselves in
future cycles
For infinite life alternatives, simply multiply P by i
to get AW value

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Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco