living with the lab

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living with the lab
Engineering Economics

• Engineers are often called on to make financial
  decisions
• engineers may serve as managers or even the CEO
• engineers may review bids from equipment
  suppliers
• engineers may need to justify new equipment based
  on the rate of return
• engineers make decisions in their own personal
  lives

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Simple Interest
Simple interest ignores the interest accrued.
There is no compounding of interest.
 
Total value after 5 years 1,000 500 1,500
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Class Problem Simple Interest
living with the lab

• You need 300 cash today to pay for some tires
  for your car, so you visit Fast-Freddie Payday
  Loans. To get the money, you are required to
  write a 345 check that Freddie will cash in two
  weeks.
• What is the simple interest rate assuming a loan
  period of two weeks (n1)?
• If you are unable to pay and the interest rate
  holds for a full year, how much will the 300
  loan cost you?

Solution
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Compounding Interest
Consider again the problem where I loan you
1,000 with an interest rate of 10 per year over
a 5 year period. If the interest is compounded
annually, then how much will I owe you after 5
years?
year principal interest earned per period end of year value
1 1,000.00
2
3
4
5
100.00
1,100.00
1,100.00
110.00
1,210.00
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Compounding Interest
Repeat the preceding problem using Excel assuming
monthly compounding.
 
month principal interest earned per period end of year value
1 1,000.00
2
3
. . . . .
60
compare to simple interest and to compounding
annually
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Derivation of Future Value for Compounding
Interest
It would be a pain to have to manually compute
the future value for every problem (as we just
did for monthly compounding). We NEED a formula!
interest earned 2nd period
 
 
 
Generalizing for n periods yields . . .
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living with the lab
Class Problem Compounding Interest
If I loan you 1,000 with an interest rate of 10
per year compounded monthly over a 5 year period,
then how much will you owe me after 5 years?
Solution

• Comparisons
• simple interest F 1,500.00
• interest compounded annually F 1,610.51
• interest compounded monthly F 1,645.31