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Engineering Economy

Page No. 1

Chapter 1: Money-Time Relationships and Equivalence


1.1 Introduction:
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Time value of money: it is recognized that a pound today is
worth more than a pound one or more years from now because
of the profit it can earn.
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1.2 Simple interest:
J %(%GQ8_!`Fa&%V
'Esimple interestF/M*LFV
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6'/ f/FL?Rgh'6*)+(%
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Simple interest: it is calculated based on principle amount
only.
Example 1.1: what is the future equivalent of L.E 1,000
invested at 8% simple interest per year for 2 years?
Solution:
V< F/ f &'D V
'&QF
simple interest rate /nLa a U
 K)*+(%
_!`Fa
C/FLe4(%
1 %'future equivalent [ [ oLQ* %FU
 Kfuture equivalent = L.E 1160 [ [ [ =Dr(%
)*+Z
 /F5=aVs '
)Y /M*LFV
' 5$C4o*U

Engineering Economy

Page No. 2

1.3 Compound interest:


oLt(%
J %`F=D@&oLtV
'Ecompound interestF/F5=aV
'
V
8*D ,*)+J %WCu8,W 6D`!_'
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8/ %*D /F5=
SF6*)+{ZC - &'
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\%
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'=D!(%
34)*+{'
Compound interest: it is calculated based on the principle
amount in addition to interest occurred in preceding periods.
_!`Fa&oLtM*LFV
'/M*LFV
'/F5=aV
'1STSF_@@'=Q@
 K
`!_'Fa&oLt/=4aV
'* 
Example 1.2: What is the future equivalent of L.E 1,000
invested at 10% compound interest per year for 3 years?
Solution:
 /+ E=w x ?@
% 5`F=D@&[[ oL@ ?@&QF
/F5=V
' a U %FU
 K/+ g5';?R +K=(%+R<
Year

Amount owed at
beginning of year

Interest amount
per year

Amount owed at end of


year

L.E 1,000

L.E 100

L.E 1100

L.E 1,100

L.E 110

L.E 1210

L.E 1,200

L.E 121

L.E 1331

 $5 /M*LFV
' x/F5=aVs ' ,gy g5="@%6 '
D %
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/ #=?}5 81x)
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RY
+TagQ&Q,
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1.4 The concept of Equivalence:
)*+JJ@A'?$ ua ?"%6equivalence @F'?
/+ oL?@@e+*4'6%a)
*)+[[ 
)\Yg%6=4';?@;h8
%,
 t8;7 &;MFDV/;+/ %V;/UCF;M7?@ %6
;\'FL5;?@&QF
  R*)+/UCF;%M;@'187@;
 Ke=LD;FL5e=LD

Engineering Economy

Page No. 3

[[ (%
;
>=<6'=a@'7Q V <"*)! e=LD;?@/=7
R L6,*)+@/MQ?;+ / %Cu)*+QF
,*)+
 Kequivalence[[ [ [@F$K/ %)*+
The concept of equivalence: L.E 1,000 today is economically
equivalent to L.E 1100 one year from now if you have an
interest rate 10 % per year.
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% 5 @tT6(%
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cash flow[[[= 6RKcash flow diagram[ [ [K$<diagram[[ 
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1.5 Cash Flow Diagrams:
 K;'1/C%%/<Rcash flow diagram[[ 
 D$5/u u/*? uX!/L(%
;guV<
\w;?@ RQ8@GD4
/+ ? 6/ 46 ?@(%
=wx/ >=  =@4
(%
VRn4
4;@7 
\<(%
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VA8/
?guGm&o4*<R@ @7 D 6
 K> !< 34/ /L/
/*? /L/
?gu$/=
$ %'Gm<;/* @<M uR'cash flow diagram[[ 4? 6
 *YKKK=QgDRREcash in flowF D (%
7F*+/D@'

< aREcash out flowF %8(%
7F*+/% U'$ %&QF
;Gm<;
 KYKKKKK *4
Cash inflow (revenues, income, receipts)
Payment Period (year, month, quarter)

x)
YKR
5)'6

End of year 2, beginning of year 3


0

!R/=L F846/Q%
3

Cash outflow (cost, expenses)


Cash flow diagram

*5=6%g4& \Q,

='y >+<C
x%'6 Re 5=W
 K? 6$=5< 

Engineering Economy

Page No. 4
 K/nLR@ cash flow diagram [[ [= 6R

C;?eMm$3>F6KGF-6 zS_cash flow diagram [[[ = 6


 
 KGMF/*%

t7month , year or quarter gpayment period [[ [ [EF
 Kcash inflow or cash outflow  *8gperiod g@
 Kcash flow [[ [ [&V+aperiods [[ [ [EF
 KS*t ?)4\cash outflow cash inflow g5>TEF
 KeMm$3*FM6/Q
=UKcash flow [[ [ [ [< /Q
=U *7ST*  Q ua
Example 1.3:
Before evaluating the economic merits of proposed
investment, the XYZ corporation insists that its engineers
develop a cash flow diagram of proposal, An investment of L.E
10,000 can be made that will produce uniform annual worth
revenue of L.E 5,310 for five years and then has a market
(recovery) value of L.E 2,000 at the end of year 5, Annual
expenses will be L.E 3,000 at end of each year for operating
and maintaining project. Draw a cash flow diagram for the
five year life of the project; use the corporation's view point.
Solution:
 Kyear [[ [ [ [/nLa$3\+/tTPayment Period g@EF
 Kfive years cash flow [[[ = &periods [[ [ EF
 KEfive year life of the projectF
 Kcash outflow[[ [ cash inflow [[ [ EF
1. Investment of L.E 10,000 at the beginning of project (cash outflow at beginning of
year 1).
2. Annual worth revenue of L.E 5,310 for five years (cash inflow from year 1 to year
5).
3. Market (recovery) value of L.E 2,000 at the end of year 5 (cash inflow).
4. Annual expenses will be L.E 3,000 at end of each year (cash outflow).

 W6r 5cash flow diagram [[[ SF


  


L.E 2,000

 

L.E 5,310


0 1
L.E 3,000
L.E 10,000




Engineering Economy

Page No. 5

1.6 Factors Definition and using of tables:


J Cu(%
%? u}1+ 1/*T
</CV< FWFactor )
Y(%

 K7F\,*ML.E 1,000 future worth [[  LWfactor
 K1?Q@tables [[ [ [- factor[[ [ [/* L
)?@7 D
[[ [ &6 '_g 4V<Qt6)?@&%factor[[ [ [ [</ =aV< o 5
 Kgs Lag> 8=%)*8eC
%6%z ?QFU@x%%'
 Rcash flow
 W  ua3Dn?table [[ [ factor[[ [ /*
/t'>ME@<Kfactor (P/A,5%,14) [[ [ [ [ /*o*+@
)\@4%@<&$5%interest rate = 5% [[ [ @8 *4
[[ [ [ /*R@? _ /*QK14 [ [ [ [1L g_ @W@?P/A
 KEA5@';?RV< &FKfactor

i = 5%
n

P/A


[[[/*R
;?@factor

14

1.2485

 $








1 5factors D  @ 


 -Lfactors [[ [@
)
? 63418E 5*6@111/Co**"=%67?@factor g5\/+ @
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 K?D 6 ?L6&QF
 factors [[[*;L? *)* &QFdisk [[ &4

%)
Y
)Y1Gfactor g5o
+K ?factors [[[  -$R +K

5$=5)* u/
<)\$5%E1?Q$3B'MxF)  ?Q7MU 
  *' *;?J< F\G&@ Qx8= <Q6 ')&6
 K=\*5@*5@?!_6"=%*5(%
K/m8=



Engineering Economy

Factor

Factor Formula
F = P ( 1 + i )N

Single Payment
Compound amount
factor.
Finding F(Future
Worth) when given
P(Present Worth)
F = P (F/P , i% , N)

Page No. 6

where i : interest rate


N: Number of periods.
F =??
0

P=

P = F ( 1 + i )-N

Single Payment
Present Worth
factor.
Finding P when given
F
P = F (P/F , i% , N)

Uniform Series
Payment Compound
Amount Factor
Finding F when given
A ( Annual Worth )
F = A (F/A , i% , N)

P =??

F=
N

( 1 + i )N - 1
F=A

F = ??

A=
0 1

Example

Cash Flow
Diagram

Suppose that you borrow L.E


L.E 8,000
8,000 now, promising to repay
the loan principle plus
accumulated interest in four
0
4
years at i = 10% per year, How
much would repay at end of
F =??
four years?
An investor has an option to
L.E 10,000
purchase a tract of land that
will be worth L.E 10,000 in six
years, if the value of land
0
6
increases at 8% each year
How much should investor pay
P =??
now for this property?
Suppose you make 15 equal
F =??
annual deposits of L.E 1,000
each year into a bank account
A = 1,000
paying 5 % interest per year,
the first deposit will be made 0 1
15
one year from today, How
much money can be withdrawn
from this bank account
immediately after 15th
deposit?

Solution
F = 8,000 (F/P , 10% , 4 )
F= 8,000 ( 1.4641 )
F = L.E 11,712.8

P = 10,000 (P/F , 8% , 6)
P = 10,000 ( 0.6302)
P = L.E 6302

F = 1,000 (F/A , 5% , 15)


F = 1000 (21.5786)
F = L.E 21,578.6

Engineering Economy
Uniform series
payment present
worth factor

Page No. 7

( 1 + i )N - 1
P=A

N
i( 1+i )

Finding P when given


A
P = A (P/A , i% , N)

A=

01

P =??
Uniform Series
payment sinking fund
factor.

i
A=F

N
( 1 + i) - 1

Finding A when given


F
A = F (A/F , i% , N)

F=
A =??
01

Uniform series
payment capital
recovery factor
Finding A when given
P
A = P (A/P , i% , N)

i(1 + i)N
A=P

N
(1 + i) - 1
P =
A =??

01

If a certain machine
undergoes a major overhaul
now , its output can be
A = 20,000
increased by 20% which
translates into additional cash
flow of L.E 20,000 at end of
01
5
each year for five years , if i =
15% per year , how much can
P =??
we afford to invest to
overhaul this machine ?
An enterprising student is
planning to have personal
saving totaling L.E 1,000,000
F = 1,000,000
when she retires at age 65,
she is now 20 years old, if the
annual interest will average
01
45
7% over the next 45 years on
A = 1,000
her savings account, what
equal end of year amount must
she have to accomplish her
goal?
What uniform payment at end
P = L.E 1,000
of eight successive years is
01
8
equivalent to L.E 1,000 at the
beginning of the first year,
A =??
Assume that interest rate =
10% per year.

P = 20,000 (P/A ,15% ,5)


P = 20,000 (3.3522)
P = L.E 67044

A = 1,000,000 (A/F, 7%,45)


A = 1,000,000 (0.00350)
A= L.E 3500

A = 1,000 (A/P , 10% , 8)


A = 1,000 (0.18744)
A= L.E 187.44

Engineering Economy
Uniform gradient
present worth factor
Finding P when given
G (Gradient)
P=G(P/G , i% , N)

Uniform gradient
annual series factor.
Finding A when given
G
A = G (A/G , i% , N)
Uniform gradient
compound amount
factor
Finding F when given G
F = G (P/G , i% , N)
( F/P , i% , N)
Geometric Series

Page No. 8

1 (1 + i)N - 1
N
P=G

N
(1 + i)N
i i ( 1 + i )

Suppose that one has cash


flow as follows :
End of year 2 = L.E 100
End of year 3 = L.E 200
G
F=??
End Of year 4 = L.E 300
A=??
Calculate their present
equivalent at i = 15% per year.
P =?? 0
1
N
Calculate
the annual equivalent
1

N
A=G
to cash flow in previous
N
i (1 + i) - 1
example.

G (1 + i)N - 1
F=
- N
i
i

Calculate the future worth


equivalent to cash flow in
previous example.

( 1 + E )N
- 1

( 1 + i)N

P =D
E -i

Suppose that geometric


gradient begins with L.E 1,000
at end of year one and
increases by 20% per year
after the first year ,
determine the present worth
for 8 years study period if the
interest rate is 25% per year .

P
0

D
1

E
N

P = 100 (P/G , 15% , 4)


P = 100 (3.7864)
P= L.E 378.64

A = 100 (A/G , 15% , 4)


A = 100 (1.3263)
A= L.E 132.63

F = 100 (P/G , 15% , 4)


(F/P , 15% , 4)
F= 100 (3.7864)(1.7490)
F= L.E 662.24

( 1 + 0.2 ) 4

- 1

4
( 1 + 0.25)

P = 1,000
0.2 - 0.25
P = L.E 3,103.07

 K F3\/MQ?=D@V
+/MQgQ?,)QX %6
5 ' 846a$5Q;57?@"<  ?@KKKKKKfactors [[[;DD@$

Engineering Economy

Page No. 9

1.7 Nominal and Effective interest rates:


Effective [[ [Nominal interest rate [[[1="@
)'=%?

/
F\
effective [[[ KKKKK&STR@g *'=Kinterest rate
 *oL4R(%
,  &'D /*%'V
'interest rate
"< /*V
8Nominal interest rate [[ [* VA8g5 5oL4* =a
E <@@46
%Nominal interest rate = 5% 7
 ?@7@+(%
)
Y(%

 ?!/_ xRV
'@+ST/*V
8/5&%$
67 =a
 Kg@@/Q*QWV
'A5@464
 7*/nLa\interest rate [[ [7
* ?7gs La\R ?'=*o*U
i = 9 % per year compounded Monthly.
interest  *LVA'RPer /5%VA87

$5%<7
*(%

compound [[[ * Lcompounded /5%/*? 6VA87




%period (IP)
 Kperiod (CP)
i = 5 % per year compounded yearly 7Q
(%
IP = CP[[/nLa*;\Q
CP [[[  DV x4F+ @Effective interest rate  ?M"=%6&QF

 Keffective interest rate  ?$="=%6i = 9% per month R


 K8 uaRNominal interest rate R&QF
CP IP ;*Q @
[[ /
LCash Flow [[ &/ =Payment Period[[[46gs La@ \
 KIP  h
@/
LCP
 RYK1
L*IE=61
L ?5 )
Yg%6o*U
 K ?; VA8R!)=64;?@J
Y\Ta 8Cash flow [[[/FL 
i = 9% per J(%
<R@\ =T L
=U y6<Q6IP [[ [ [/FL 
xnL6  %FU\< TE=6/ IP [[ &I month compounded yearly
i = 108% per year compounded V
'SF6K=w *8/L!&%
 KIP )*8 =T\?'=[ [= T @7 eD*5@ %FUKyearly
 $ ?Q-L6CP [[[ y6;*F
i=(1+

r M
) -1
M

Where: i = effective interest rate r = Nominal interest rate


M = No. of compounding periods.
 K$ ?QFM6R7tT*R + ua


Engineering Economy

Page No. 10

Example 1.4: if the interest rate is 12% per year, what is the
nominal effective per year compounded monthly?
Solution:
 &QF6 ?Q-LM  %FUmonth XYYear CP [[[

R/nLa \%FU
RgW&QF
R=a*)nL6&M = 12 [[ [i = 12% [[ [*  

 Rr
 K$5
w;? 
i=(1+

r M
) -1
M

0.12 = ( 1 +

r 12
) -1
12

r = 11.4 %

?  F&xI& @%FU !F/


?XY  F/4Fw1%Ls_ @4?$4
%&Q 6&7F+/F4&V@R w/
5=w/
wS
<$5& ,
 K? u F\xI7?@\=48$5






















Engineering Economy

Page No. 11

Chapter 2: Applications of Money-Time Relationships


2.1 Introduction:
CuRY(%
Cash Flow Diagrams[ [ [  &%e  L/
w& ?*5=64* F3\
Internal [[[ [oL@Cash Flow R!Equivalent present worth [ [ oL
 K34Cash FlowR!rate of return
2.2 The present, Future, and Annual worth equivalent for
any cash flow diagram:
Present worth , Annual worth, and g5 section [[[ [3\
 KCash Flow diagramR!Future worth
Present [ [ Y
)@Y(%
Preset worth equivalent [[ [>/
F@\F? %6
cash R(%
/nLa\Rcash flow diagram [ [ [equivalent $worth
=8e + /
wGeometric series Gradient Annual &Rflow
Present )F*$5 ?@&QF
0 [[[ [/8 4V/*)G$7%g5g*w@;*F
X %6R@xF  @x8 )L
/+ ;8Kworth equivalent
 KFuture worth [[[ Annual worth [ [ [  ?>6$C4*?'%?
Cash flows [ [ g5g*w@(%
Annual worth equivalent )
Y(%
@Fa'
R L4
/ =D@Wcash flow [[ [&/ @@F
Annual #G@R
 K*
Future G@R7%g5g*w@(%
Future worth equivalent )
Y(%
o*U
cash [[[/
?\ M@V/*QRcash flow[[[g5F @(%
*\ 4worth
 Kflow
R!\ 4a'=;%[[ @
) s)L'?E=M
R3OL&QF
'ST)QTa@Q@
#G@Rcash flows[[[g5g*w@?@4V=a/ +cash flow
 K;
='
 W1
K=
ML\,W FR@V=T @$ C4g5 -?$  %?o*U
(1) Present worth Method (PW): This method is based on
the concept of equivalent worth of all cash flows at beginning
point in time called present.
(2) Annual worth Method (AW): The annual worth of a
project is an equal annual series of pound amounts for a
stated study period that is equivalent to the cash inflows and
outflows at an interest rate (MARR).

Engineering Economy

Page No. 12

(3) Future worth Method (FW): The future worth is based


on the equivalent worth of all cash inflows and outflows at
the end of study period.
 K8) 46C4;* Fu?gs L/
wD ?$  %6
Example 2.1:
A piece of new equipment has been proposed by engineers to
increase the productivity of a certain manual welding
operation , the investment cost is L.E 25,000 and the
equipment will have a market value of L.E 5,000 at end of
study period of five years , increased productivity
attributable to the equipment will amount to L.E 8,000 per
year after extra operating costs have been subtracted from
the revenue generated by the additional production , if the
MARR is 20% per year , calculate the equivalent present
worth of cash flow .
Solution:
 eMm'cash flow diagram[ [ < /nLa \%/+  @%FU
/nLa cash flow[ [ [< X %6$5% %+<E= <5 8x %FUe 8 F* \
L.E 8,000

L.E 5,000 K$5J %>M*)?@5 6R


5





L.E 25,000

 #o*/+ g5g*?(%
Present worth equivalent[[[ o*

 Y$5%
 *? f/+  *8g@ x8='[[ 25000 [[[ [/
='[[ [ cash flow
 ?@Factor[ [ [V<_&V +0[ [ P F*+@ Annual [ [ 8,000 [ [ [
Present F*+@
Futureg4w&5,000 [[[D@P/A $)8 
V  L6 7?/nLaggVD@/+ gT 8KFactor P/F[[[  -L*5@
 K$/nLago4?$5Ko ;o+8[[ e <w
PW = - 25,000 + 8,000 (P/A, 20%, 5) + 5,000 (P/F, 20%, 5)
= -25,000 + 8,000 (2.9906) + 5,000 (0.4019) = L.E 934.3

Engineering Economy

Page No. 13

Example 2.2:
Determine the AW of the following engineering project when
the MARR is 15% per year.
Proposal A
Investment cost
L.E 10,000
Expected life
5 years
Market ( Salvage ) value
- L.E 1,000
Annual Receipts
L.E 8,000
L.E 4,000
Annual expenses
Solution:
 a(<@%6Investment cost [ [  8+g R/nLa Cash flow [[[  < %FU
$5%0 [[[cash out flow=Dn[(%
/
F=\a)\M 
5 yearsR/nLa\cash flow[[[ < &VA'(%6expected life [ [ 
 4*)%* $=/
?\=a*>+ a(%6Market (salvage) value [[[ $5%
@Annual receipts [[[ $5%cash flow[[[ [/
?\cash in flow M (%

'=*@cash flow [[[ [M*annual  AAnnual expenses [ [


 Aannual expenses [[ [ * cash in flow  AAnnual receipts [ [
 /C>K =  5cash flow [ [ SF
Kcash out flow
Total annual = annual Receipts (cash inflow) annual expenses
(cash outflow) = 8,000 4,000 = L.E 4,000


L.E 4,000
0

5
L.E 1,000

L.E 10,000





@BC %FU$cash flow [[[ equivalent [[ Annual worth [ [  $5%
%factor A/P [[[ - (%
Annual  F*+ present FR10,000 [[ [
 W/nLagSF
Factor A/F - (%
A  F*+ F %61,000 [ [ $5
AW = 4,000 10,000 (A/P, 15%, 5) 1,000 (A/F, 15%, 5)
= 4,000 10,000 (0.29882) 1,000 (0.14832) = L.E868.48



Engineering Economy

Page No. 14

Example 2.3:
Determine the FW of
the following cash flow:

L.E 5,000

L.E 8,000
0

i = 20% per year






L.E 25,000

Solution:
 KF /+ g4o* "@CDg56 81nLa * /Q
=M '%FU
FW = 5,000 + 8,000 (F/A, 20%, 5) - 25,000 (F/P, 20%, 5)
= 5,000 + 8,000 (7.4416) 25,000 (2.4883) = L.E 2325.3
Future , present and annual worth equivalent [[[  D %, %FU
 KInternal rate of return V
+/+ &x-

2.3 The internal rate of return (IRR):
 *_ D  D/
 Interest rate IRR [[ [ [IRR )
Y(%
"=%?

/
F\
 - cash flow [[ PW or AW or FW [ [ o* aY *V'=aV*
 K=Dr(%
K0 $$C4C6factor [[[ \Mti [ [? Y& *%6(%

PW=AW=FW= zero at i = internal rate of return (IRR)


AW @PW o*+@/U Lg47 Cash Flow Diagram R!IRR [[ [Ro*o*U
\}V/ %R&QF6zero [[ [ )
@ Rcash flow [[[ FW @
 K )FL@i [[[ 
 W6r ua ?"%6
Example 2.4:
Given the following cash flow diagram, find the internal rate
of return to this cash flow.
L.E 350
01

L.E 7,500

24

Engineering Economy

Page No. 15

 K='[[ [ )
L?cash flow diagram [[[  PW[[[ o*/+ @
P0 = - 7,500 + 350 (P/A, i%, 24) = zero
(P/A, i%, 24) = 21.43
 W@/ %ai [[ [ /*oL@R)L'?E=M
 OL$5%
=I%6 )/ %a)GFactor g5g*67?@/Q
=U@Ki [[ [ LW/Q
=U$35\
5Rcash flow [[[  5Y/_ D+/
U/F%_/Q
=URi [[ [/*o* W
 K/Q
=M$3x-L $5 KR/nLaRg x
>M6P [[[ "6i = 10% [[ [G(%
i [[ /'*Q%67?@&%6/*? u/Q
=M
[[ -LE=6o ? o+*8V ?;\5P [[ [ 1=g_6 W 4*J %
 Ki /* interpolation
\i [[[/*>M? RY/Q
=M3FM?"? %67
/+ x8 7?@"<  ?@ %FU
 K8/nLa
 Ko+ 1;F*P [[ 1*Q _ Wi [[ *Q%? h8 @
i= 0.75 %
i= 1.00 %

P = L.E 161.185
P = - L.E 64.81
 6r 5;? 5Kx <&i [[ Y <&P [[ [1/*? */C <$5%


Present Worth P0

L.E 161.185
1.00%
- L.E 64.81

Interest rate i%

0.75%

 W@Q?(%
interpolation [[ [ -L?$5%
161.185 + 64.81 =
1% 0.75%
0.75% i%
1.00%
64.81
1%- i%
i = 0.93%
*/
wP [[[ 5*/
wo
+E=67?@
=U?1?z/nLag4 5
i[[ o*&t*g_6scale [[[ R*Qgu* ?F= /t'S
<E=6i [ [  5
 Ki [ [ [<>&ta>U Q6/MQ?8/=&
 K u F>D&48?*/Q/
?XYg? XY
 KD&tF6C

Engineering Economy

Page No. 16

Chapter 3: Comparing Alternatives


3.1 Introduction:
7?@A'?(%
AlternativesgsF
%1/?< Qa V a/ #e Q*FM@
e*a"/+ *gT '6
e 5=w=7 +7%a/4RA6S
<
=8@1"6(%

* gT '/*'/*Qe*a \L
 %/4g5\/*Q
 K u FT$/?< QaT@A5@S<7*<*
(%
* <QgsFg5/ cash flow[ [ [ A7?@/?< Qa/*\ %6/+ @
$3V-L6@F6$5%V< * g4Cash flow  A F
* <Qe * <J
 K -L6/Q
=UL@"6x4  t\7 
oL/?< Q=M
 Kpresent worth[ [ - /?< Qa 4/Q
=U@
2.2 Comparing Alternatives using present worth method:
Kstudy period [ [ [\1
LRcash flows[[[ g54
@/Q
=M$3*FM6=w
PWo*+7?@RST7<oFL %FUYKKKKKK1 5@1 5(%

46 %8K1 7)6cash flow [[[PW[ [ *5@1 5 )6cash flow[ [


 Kperiods[[[ [ \/
LRcash flows [[[ [g546/ /?< Qa
>'
g=w72)6? 6cash flow 1 6 )6cash flow JY7 D
 R 
'>!=%FU*5@Present worth method [ [ [- * <Q6
 Kstudy period [ [ \1
L?Qt
periods[[[ \1
LxRcash flows[7=\MD*5@? 6O o*U
 K L
 Wcash flow g5=
=46
=U1
L*I@/U Lg4K
)Yg@
? 6cash flow 1 4) study period [ [ cash flow J(%

study period [ [ [ F8e=?=<!4E=61 6 ) study period [ [ 


>'
  $=/ 12 ) study period [[[  F816=? =<4E=6/ 12) 
 KLCM *Lcash flows1f!  Q6/LKPW[[[ - *@ <
 W/_Cm
When you compare between alternatives using present worth
method, the useful lives for all cash flows should be equal.
 KPW Method[- /?< Qa&/u@/
w"?%6




Engineering Economy

Page No. 17

Example 3.1:
Two projects are being considered to update power station,
the table below show the cash flow diagram for the two
projects, if MARR is 15% per year, which project should be
selected?? (Using PW Method)
Project A
Project B
Initial Investment
Net Annual Cash
flow
Salvage Value
Useful Life
Solution:
(
'> <%
study period

L.E 9,000
L.E 2,400
L.E 0
6

L.E 6,000
L.E 1,600
L.E 300
6

[[[ \1
LRcash flows16@ST %FU
 KPW Method [ [ - M*
 Kcash flows1f ? = %/+ @

L.E 2,400
0 1

L.E 9,000

L.E 300

L.E 1,600
0 1

L.E 6,000

Cash Flow Diagram for Project (A)

Cash Flow Diagram for Project (B)


 K*8g4Present worth [[[ o* %6/+ ? 6
PWA = -9000 + 2400 (P/A, 15%, 6) = -9000 + 2400 (3.7845) =
L.E 82.8
PWB = - 6000 + 1600 (P/A, 15%, 6) + 300 (P/F, 15%, 6) =
= -6000 + 1600 (3.7845) + 300 (0.4323) = L.E 184.89
 PWB > PWA!Proposal A [[[ [ gh8@Proposal B [ [  !< @%FUST
 KB is selected &QF*8

- study period [ [ \1
LxCash flows161 <Q*R + ua
 KRY* <Q"? %6PW Method [ [



Engineering Economy

Page No. 18

Example 3.2:
The following data have been estimated for two mutually
exclusive investment alternatives, A and B, associated with a
small engineering project for which revenues as well as
expenses are involved. They have useful lives of four and six
years, respectively. If MARR = 10% per year, show whish
alternative is more desirable by using present worth method.
A
B
L.E 5,000
Capital Investment
L.E 3,500
L.E 1,480
Annual Cash flow
L.E 1,255
6
Useful life (years)
4
Market Value at end
0
0
of useful life
 $5 study period [[[ \1
Lxcash flows 16@ST %FU
study [[[SF16=? e=?!e<=5 L*?@ST L
 W<=5@
 K/ 12  #period
 KRY ?<=5 Y"w=
=4%gFcash flows [ [  &

L.E 1,255
01

L.E 1,255

Cash Flow Diagram for Project (B)

L.E 1,255
4

L.E 1,255
8

L.E 3,500

12

L.E 3,500

Cash Flow Diagram for Project (A)

L.E 1,480
0 1
L.E 5,000

L.E 5,000

Cash Flow Diagram for Project (A)

L.E 3,500

 

0 1

L.E 3,500

01

L.E 1,480

L.E 1,480
6

L.E 5,000
Cash Flow Diagram for Project (B)

12

Engineering Economy

Page No. 19

 W* <Q?Cash Flow g5 Present worth [[[ [o*$5%


PWA= -3,500 3,500 (P/F, 10%, 4) 3,500(P/F, 10%, 8)
+ 1,225 (P/A, 10%, 12) = L.E 1,028.
PWB= -5,000 5,000 (P/F, 10%, 6) + 1,480 (P/A, 10%, 12)
= L.E 2,262.
 KB [[[  <D *5@&QF
PWB > PWA[[[  @a U

/?< QV
+/Q
=U"? %6PW Method[[[ - /?< Qa D $5
 KAnnual worth[ [
3.3 Comparing Alternatives using Annual worth Method:
Annual [[[ o*+ ?@&%6Annual worth Method[[[ - /?< Qa/Q
=U
x='6  F
Annual worth o*+  ?@ a U* <cash flowg5 worth
)
Y=@L-*@oL4*cash flow g5o*+ =Dr!?\!/
Lstudy period [[[
%
 <x%'* 8Cumonth [ [ ? /L cash flow R@7 DCu/ g5
=D!>\M
 16 1
L*D@(%
Annual worth [[[- U&
 K**'>@ <8per year @per month 11<
 W/_Cm
When you compare between alternatives using Annual worth
Method, don't care about the useful lives are equal or not,
but care about the useful lives have the same period.
 KAW Method[[[ - /Q
=UST
 uD ? %6
Example 3.3:
Two mutually exclusive alternatives for implementing an
office automation plan in engineering design firm are being
considered. Each alternative meets the same service
(support) requirements, but differences in capital
investment amounts and benefits exist among them. The
useful lives of alternatives are 10 years, Market values of
alternatives are assumed to be zero at end of their useful
lives, if the MARR is 10% per year, which alternative should
be selected Using AW method?

Engineering Economy

Page No. 20
A

Capital Investment
L.E 390,000
L.E 920,000
L.E 69,000
L.E 167,000
Annual Cost savings
Solution:
 KAlternativeg5/ cash flows[ [@ ?= /nLa \%/+  @%FU

L.E 69,000
01

L.E 167,000
10

L.E 390,000

01

10




L.E 920,000

Cash Flow Diagram for Project (A)

Cash Flow Diagram for Project (B)

 KCash Flowg4AW[[[ o*$%


AWA= 69,000 390,000 (A/P, 10%, 10) = L.E 5,547.
AWB= 167,000 920,000 (A/P, 10%, 10) = L.E 17,316.
 KB is selected F
AWB > AWA[[[ @ST %FU

 K$< -1"6AW[[[ PW[ [*&1nLagE=64$5
 KInternal rate of return[ [ /Q
=U/?< Q/ /Q
=M&
 K/?< Qa \-LRY"? %6

3.4 Comparing Alternatives using Internal Rate of Return
Method:
cash flow [[[   %g5@/Q
=M$3- >\s wnMmJ F?@? 
/
F\
 K  Project [[[  <IRRA5@"
IRR[[[ F**Alternative g5
 K  DGz$C4
 K)
Yg%IRR- /?< Qa/*\@
XYcapital investment =y_@/
Jcash flows[ [ o6=67?@/+ @
J&
ycash flow 16E=U{6 cash flow [[[ o*$5%K5@
 KIRR[[[ FL
x8 7?@"<  ?@ %FUy <I=y_@;%UF4 <IMARR[[[ [5@;%U8
 KRY)t"? *G*LExample D ?X %6 /+ 

Engineering Economy

Page No. 21

Example 3.4:
Suppose we are analyzing the following two mutually exclusive
alternatives for a small investment project, the useful life of
each alternative is four years, and the MARR is 10% per year,
which alternative should be chosen using IRR method?
A
B
L.E 73,000
Capital Investment
L.E 60,000
Annual revenues
L.E 22,000
L.E 26,225
less expenses
Solution:
capital [ [ [oLR 6o*6=6Jcash flows[ [ [o6=67?@ %6/+ @
 K=D!)\MF4)\!Mcapital investment [ [ \y(%
investment
capital [[ [=\y_!A !F4yC%81F6A*C8K\G*L %FU
 KB [[[ investment
(%
Ey F4 %FUFcash flow 16E=U{6 ?
+cash flow o*$5%
 KB A o*=Dr
Capital investment
Annual revenues less expenses

BA
L.E 13,000
L.E 4,225

>+<RYIRR [[[ o*=5 8x %FUcash flow B-A [[[  IRR [[[ e $5%
 K?  F>+<
P0 = -13,000 + 4,225 (P/A, i%, 4) = 0
i = 11.4% per year.

L.E 4,225
01

L.E 13,000

Cash flow diagram (B A)

 * <Q?B A Incremental cash flow [[[  IRR [ [ [o* % %FU
 KMARR[[[ 1
 KA < D@g@;%UB < DMARR[[[ [5@;%U
 KB < -$5 MARR[[[ 5@;%U  /nLa \%FU

Engineering Economy

Page No. 22

2 alternatives A5@R 5g


)Y"?$  %6ST$ Ta@Q@
 K) 
)Y
Example 3.5:
Suppose we are analyzing the following six mutually exclusive
alternatives for a small investment project, the useful life of
each alternative is ten years, and the MARR is 10% per year,
which alternative should be chosen using IRR method?
Capital investment
Annual revenues less expenses

L.E 900
L.E 150

L.E 1,500
L.E 276

L.E 2,500
L.E 400

L.E 4,000
L.E 925

L.E 5,000
L.E 1,125

L.E 7,000
L.E 1,425

Solution:
capital 5capital investment =y_!F6=67?@ %6/+  @%FU
o*16=y_@7L$5%/
FF6=7= ?@ %FUinvestment
 ?< Q6IRR[[[$FLB A   )incremental cash flow [ [
7=U@?n '5  %FU ?@E;6 8/nLa  \RF< -*1"6MARR[[[ 
 <E=6;?@'=aF;%UIRR [[[ 7 $5%%cash flows [ [
K=7*xU  aE {6   ?< Q6IRR[[[Fcash flow [ [
 KRYTa?;'R +
Capital investment
Annual revenues less
expenses
IRR
Whish project is
selected

BA

CB

DB

ED

FE

L.E 600
L.E 126

L.E 1,000
L.E 124

L.E 2,500
L.E 649

L.E 1,000
L.E 200

L.E 2,000
L.E 300

16.4 %
B

< 10%
B

22.6 %
D

15.1%
E

8.1%
E

 K=DrW FL5gh8!?)E < -=D! \%FU ywR $5ST %FU


 W6!g4\V+IRR[[[-  <Q6*6 a%/_CD


Arrange Alternatives by increasing capital investment


(from low capital investment to high capital investment)

Develop Incremental cash flow:


Incremental cash flow = next cash flow (B) current cash flow (A).




Is IRR (incremental cash flow) > MARR??


No

Yes

No

No
Is this the last cash flow?
Yes

Stop!!, this is a preferred alternative (A)

The (B) is the current cash flow

Is this the last cash flow?


Yes
Stop!!, this is a preferred alternative (B)




Engineering Economy

Page No. 23

"? %6KCapitalized worth method [[[ - /?< Qa/?< Q/Q


=U=D@
 K)
Y4R/Q
=M
3.5 Comparing Alternatives using the Capitalized worth
Method:
Q6&@Kinfinity[ [ ) study period [ [ =J4*7?R/Q
=M
\Kg5
@AW ;? 5 7F%6/Q
=M    <DR /nLa< /+ R@@o*7w
infinity[[[ *8n [ [ F F4factors[ [@7 Q/4ag5PW
 KR/C%-LMEAK* \Cx %FU
PW =

AW
i


 K * uD ? %6g5 * 8   D/ R/Q
=MRY 8w
Example 3.6:
The city council wants to build new water treatment station,
the city engineers proposed the following two alternatives, if
MARR = 5%, which alternative should be selected?
Nuclear Power
Natural gas
(A)
(B)
L.E 20,000,000
Capital investment
L.E 1,000,000
L.E 250,000
L.E 100,000
Operating cost
L.E 400,000
L.E 600,000
Overhaul every 10
years
30
Life years

Solution:
xG*FL'?g@K/
? ) life years[ [ [;8w?@?
  DR
 KR cash flows1f [
' < w
0

10
20
L.E 250,000

L.E 400,000
L.E 1,000,000

30

01

10
20
L.E 100,000

30

L.E 600,000
L.E 20,000,000

Cash Flow Diagram for Project (A)

Cash Flow Diagram for Project (B)

E/
Lxlife years [ [  %FUF*/?< QAW[[[-L?@e<= ?$5%
 K) AW[ [ [)F* @Rg A =a %FU

Engineering Economy

Page No. 24

AWA = - 250,000 1.000.000 (A/P, 5%, 30) 400,000 (P/F,


5%, 10) (A/P, 5%, 30) 400,000 (P/F, 5%, 20) (A/P, 5%, 30) =
= - L.E 333,971.84
 
Annual8L.E 100,000[[[/FL //\=4'? %8? =/FL  @
=R
) Y F*P 8 L.E 20,000,000[[[/FL /+   x&QF

-L  L8infinity  Ffactor[ [/ n [ [ * @Q /4a


Vg5;4L(%
1 =g5<=468L.E 600,000[[[ /FL  @) 46 ?Q
 4$5&QF6infinity WAnnual &gt ?@&QF
1 =g5Annual 
 KRYo4*gW"w$ X %6;
AWB = - 100,000 20,000,000 (0.05) 600,000 (A/F, 5%, 10)
= - L.E 1,173,980
 KA =a <- F
AWA > AWB [ [  
 KRYgt"wPW [[[   =4'6;
<

 KR R C


K ug'/
?XY _4? XY



















Engineering Economy

Page No. 25

Chapter 4: Replacement
4.1 Introduction:
 g_@$ %* '=8&QF*K+/
*/
 /**replacement[[ [/*
3o _@ SF_@- A5o%6g_!3EKKKKKKKg
/*=/4FAsset1%

 @Y)Ma=\@L
, ag_!3#/? *_g
 @Y
< *D< *Dg_!
 K
+g_n)F
=D!(%
gs/
w1/?< Q/*A5@xreplacement[ [ [/*Y7 D
old asset and new 1comparison/nLA5@xreplacement[[[/nL
 KE
=D@ 
g_@1Fasset
x z!Re Ca/
w7 Ireplacement[[[&gs Lg\@F? gF
)87?!R +section [ [\5<7**wC
FKreplacement[ [ /nLg"=%6 
 KReplacement[ [ e=5&QF6
4.2 Factors that must be considered in replacement study:
/
/Q_cash flows[ [@?= Kreplacement[[[ /*\@7 D 6EF
/ 15TA8 = 5*)+150000[[ 1 /4;
Aw@7?@CuA'?(%
r
1000/? * *46;? 5)*+5000W[[/L/
?\/4a$3#salvage value[[ 
x1 10)=(%
,=)@/4a$3#cash flow[[= 6*6 a
 )*+
)?!/+ \
%x='
 )*;
Aw/4a=%  5/L m/L@? ,!?/ 15
 K$5&QF*/4cash flow[[[ Y7 I=D!(%
 g $x*  ?@T a\
L.E 5000
0 1

10





L.E 1000

V
+/47%/4aF6 7?@7 Dn6replacement [[ [ /*g%6*6 aEF
trade [[[ [ /+ )*8$5 K7 /4a*>F*5@/ 3\7 /4aAx*5@
 K, %Y/4a=% guin value
&/
K/4a cash flow[[ [)&Mt18$/4a=% Gt;?="%6+
cash out )Mtcash in flow )Mt=6
/Q/4a cash flow [ [
 Kflow
/*% _ ;?@(%
replacement[[[ /*%76=?g%*$C47 D
replacement[ [/*g%@?;7?n5(%
insider view[ replacement [ [

Engineering Economy

Page No. 26

V
K/4a=% 7Q*7*cash in flow)?n5 *%*F;?/Q/4a=% 7? F&QF

 K/
K/4a cash flow&cash in flow)A=Dr(%

replacement[ /*$=7?n5(%
outsider view [[T;*;?@
,/4a*)RA=%L$?)n5/Q/4a=% 7? F
8V
K@/Q/4aRA6
;8wGFh 7?n5/Q/4a cash flow [ = &cash out flow F*(%

 K 
A6S
<L\R/4a
/**g%6
Kg_!)F =a
Qg_! cash flow [ [ = 6 %EF
Annual worth [[;GAnnual worth method[ - comparison
 K/*? 6/Q
=URn <Q6%'
 (%
KGD*method
$n  ?Replacement[ [ /*\ 7 D e + W;87?@ XYQ@
 K$C4&Examples/
w"6
4.3 Typical Replacement Problems:
Example 4.1:
A firm owns a pressure vessel that is contemplating
replacement. The old pressure vessel has annual operating and
maintenance expenses of L.E 60,000 per year and it can be
kept for five more years, at which time it will have zero
market value. It is believed that L.E 30,000 could be obtained
for the old pressure vessel if it were sold now.
A new pressure vessel can be purchased for L.E 120,000. The
new pressure vessel will have a market value of L.E 50,000 in
five years and will have annual operating and maintenance
expenses of L.E 30,000 per year. Using MARR of 20% per
year, determine whether or not the old pressure vessel
should be replaced. A study period of five years is
appropriate. (Use the insider view point)
Solution:
trade [ [@J< FY\G14a cash flows[[[  A7?@/nLa \%6/+ @
- !?) V
K/4a&cash in flow [ [ 5Gtin value = L.E 30,000
 Kinsider view point[ [
01

5
L.E 60,000

L.E 50,000
L.E 30,000
0 1
5
L.E 30,000
L.E 120,000

Cash flow of old vessel

cash flow of new vessel


 


Engineering Economy

Page No. 27
 KCash flow g5 AW[[[ [o*$5%

AWA= -L.E 60,000


AWB= - 30,000 90,000 (A/P, 20%, 5) + 50,000 (A/F, 20%, 5)
=- L.E 53,376
 KReplacement[ [ [/*= 73AWB > AWA @ST %FU
Example 4.2:
Machine A was purchased 4 years ago for L.E 22,000 and
estimated useful life 10 years, annual operating and
maintenance costs are L.E 7,000 and salvage value is L.E
2,000.
The management considers replacing Machine A due to
economic reasons; the management receives the following
offer for Machine B:
Machine B price is L.E 24,000, operating and maintenance
costs are L.E 4,000, its salvage value is L.E 3,000, and trade
in value is L.E 6,000, if the useful life= 10 years, MARR is 15%
per year. Should Machine A replaced or not???
Solution:
- /nLa\/nLa/ cash flows[[[ [< /+  @%FU
 YJ< FY\G<= ?@$5 %8insider view or outsider view[ [ 
cash flow 16 study period [[ 46insider view[[ [-L6
(%
outsider view[ [ -  }
&$5 %8 nL\Qtx$1
L
 K/Q/4a cash flow [ [ &cash out flow Gttrade-in-value[ [ [

L.E 2,000
6
L.E 7,000

L.E 6,000

L.E 3,000
0 1

10
L.E 4,000

L.E 24,000

Cash flow of Machine A

cash flow of Machine B

 K!replacement [[[ /*g% 5Y<=Q?cash flow g5 AW[[[ [oLt$5%


AWA= -7,000 6,000 (A/P, 15%, 6) + 2,000 (A/F, 15%, 6) = - L.E 8360
AWB= -4,000 -24,000 (A/P, 15%, 10) + 3,000 (A/F, 15%, 10) = - L.E 8640
As AWA > AWB, No replacement done.

 K m F&x$nC
+y_ Y$ 8w> =F 
XY

Engineering Economy

Page No. 28

Chapter 5: Depreciation
5.1 Introduction:
6/4;
Aw(%
- >=<gQ*R/4a=% @JC&%
)*+10000[[[ [g@ F*/
+/L %*@;*F/4a$3*5@)*+10000[ [ [ 
10000 g@ 4**5n81 % %*@;*F)*+5000 )?@CuA'? %6
)4 g_@R@=% @/_Cm(%
)*+3000[ [ [ F ?@A'?)*+5000[[[ [*)+
 KJC$>=<gQ*
Depreciation: it is the decrease in value of Asset with the
passage of time and use.
 @R/4a JC/*%? @@%*FMJCTa  </)
Y
? n88 uaR/ *)>=<@+2000<QgQ*/4a=% (%TA8= 
 K < u *)+2000[[[ [@@R< FY\G@
 W@/_Cm F6
Annual depreciation should be covered during the life year.
5.2 Depreciation Terminology:
/C #e tM/
w?'!Depreciation [[[ gs Lg/*'*5\x gF
 KDepreciation [[[ [T
1- Initial Cost (B): the initial cost of Asset.
 K *)*6Aw@?;/4a=% (%

2- Book Value (BV): it is the original cost less all value
depreciation, and it represents the amount of capital that
remains invested.
< &JC/*_!/4aV< F/U LF,/4a%6
 K;6 81L
3- Salvage Value (SV): the estimated value of asset at the
end of its useful life.
 KTA8= /
?\/4agu
4- Useful life (n): the estimated period that the asset will
be used in.
 K/4TA8=%
 16* 5=U Depreciation[[[  L=U&x<Q?$ ,
 K)
Y"? %6


Engineering Economy

Page No. 29

5.3 Depreciation Methods:


5.3.1 Straight Line Method (SL):
gQ*/4a=% &@%6,*QLaGm/Q
=UDepreciation[[[ [=U/Q
=U@
&QF*1 %*)+8000&QF*/ %F8)*+10000,/4a 5(%
 ?
2000 / f/*/4JC/*(%
)*+4000&QF*1 eC6%*)+6000
 K/ g5)*+
 K*QLaGm/Q
=U\E/ g5/4a Q/*QF/4a/ JC/*oL@$ RY
 ==D@\ %*F1 10TA8 = 5*)+8000[ [ [ ,/4;
Aw?;/U LF
 K 54=6
/ f/*QJCY %6 F
)*+2000[ [ 
600 %FU*5@ 5gQ*/ g5&QF
1 =%CD6000[[[ g =% /4a@Q*QMa4'
 K$ ?Q)M K)*+

B - SV
n
Where: D: Depreciation amount,
B: Initial cost,
SV: Salvage value,
n: useful life.
/*_ V< F*5@Cu/L m/L\/4a="%6
o*U
D=

 K1 m&<gDepreciation [ [ 
  F*(%

BVt =B tD
Where: BVt: Book value at time t,
B: initial cost.
t: time,
D: Depreciation amount.
 %6KDeclining balance method[ [ /Q
=UDepreciation[ [  LW/Q
=U? 6
 K)
Y4R/Q
=M?"
5.3.2 Declining Balance Method (DB):
 K\ 4a>MQ&tR
 K; f%gQ6/4a/*&@%6/Q
=U
 W/Q
=M$31?  4*QLaGm/Q
=U1?   ,/Q
=M'

Engineering Economy

Page No. 30

SV
B
BVt = B (1 - R) t
R =1-n

Dt = BR (1 - R) t-1
Where R: depreciation rate.
D: Depreciation amount.
 Kdepreciation[[[ [gs L\1?Q$3*FM6/*'*5& uD ?$  %6
Example 5.1:
A new electric saw for cutting small pieces of lumber in
furniture manufacturing plant has an initial cost of L.E 4,000
and 10 year depreciable life. The estimated salvage value of
the saw is L.E 400 at the end of 10 years.
(a) Determine the annual depreciation amount and the book
value at the year 5 using the straight line method.
(b) Determine the depreciation amount at year 5 and the book
value at the same year using declining balance method.
Solution:
="%;?gW&$5 /
w  F51?Q=\w F
%6V< F/nLa/U Lg4
 K  Dg Ta

B - SV 4,000 - 400
=
= L.E 360
(a)
n
10
BV5 = B - 5D = 4,000 - 5 360 = L.E 2,200
D=

R =1-n

SV
400
= 1 - 10
= 0.206
B
4,000

(b) D5 = BR (1 - R) 5-1 = 4,000 0.206 (1 - 0.206) 4 = L.E 327,5


BV5 = B (1 - R) 5 = 4,000 ( 1 - 0.206)5 = L.E 1,262.3
 KE wY=D Q\D&$ 48wF m F/
?XY _46 XY

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