ENGINEERING

ECONOMICS [IE 551]

Tutorial Sheet 1

DEPARTMENT OF INDUSTRIAL
INDUST ENGINEERING
 Tutorial Sheet 1

1 MethodsofCalculatingInterest
ethodsofCalculatingInterest
1.1 Compare the interest earned by $1,000 for five years at 8% simple interest withthat
earned by the same amount for five years at 8% compounded annually.
1.2 You are considering investing $3,000 at an interest rate of 8% compounded annuallyfor
five years or investing the $3,000 at 9% per year simple interest for fiveyears. Which
option is better?
1.3 You are about to borrow $10,000 from a bank at an interest rate of 9%
compoundedannually. You are required to make five equal annual repayments in
theamount of $2,571 per year, with the first repayment occurring at the end of year
1.Show the interest payment and principal payment in each year.

2 Equivalence Concept
2.1 Suppose you have the alternative of receiving either $12,000 at the end of fiveyears or
P dollars today. Currently you have no need for money, so you would depositthe P
dollars in a bank that pays 5% interest. What value of P would makeyou
makeyou indifferent in
your choice between Pdollars today and the promise of $12,000at the end of five years?
2.2 Suppose that you are obtaining a personal loan from your uncle in the amount
of$20,000 (now) to be repaid in two years to cover some of your college expenses.If
your uncle usually earns 8% interest (annually) on his money, which is investedin
various sources, what minimum lump
lump-sum
sum payment two years from now wouldmake
your uncle happy?

3 Single Payments (Use of F/P or P/F Factors)

3.1 What is the present worthh of these future payments?
paym
(a) $5,500 6 years from now at 10% compounded annually
(b) $8,000 15 years from now at 6% compounded annually
(c) $30,000 5 years from now at 8% compounded annually
(d) $15,000 8 years from now at 12% compounded annually
3.2 For an interest rate of 13% compounded annually, find
(a) How much can be lent now if $10,000 will be repaid at the end of five years?
(b) How
ow much will be required in four years to repay a $25,000 loan received now?
3.3 How many years will it take an investment to triple itself if the interest rate is
12%compounded annually?

4 Uneven Payment Series

4.1 If you desire to withdraw the following amounts over the

next five years from asavings account that earns 8%
interest compounded annually, how much do youneed to
deposit now?

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4.2 A local newspaper headline blared, “Bo Smith Signed for $30 Million.”A readingof the
article revealed that on April 1, 2005, Bo Smith, the former record-breakingrunning
back from Football University, signed a $30 million package with the DallasRangers.
The terms of the contract were $3 million immediately, $2.4 millionper year for the
first five years (with the first payment after 1 year) and $3 millionper year for the next
five years (with the first payment at year 6). If Bo’s interestrate is 8% per year, what
would his contract be worth at the time he signs it?

5 Equal Payment Series

5.1 What is the future worth of a series of equal year-end deposits of $1,000 for10 years in
a savings account that earns 7%, annual interest if
(a) all deposits are made at the end of each year?
(b) All deposits are made at the beginning of each year?
5.2 What is the future worth of the following series of payments?
(a) $3,000 at the end of each year for 5 years at 7% compounded annually
(b) $4,000 at the end of each year for 12 years at 8.25% compounded annually
(c) $5,000 at the end of each year for 20 years at 9.4% compounded annually
(d) $6,000 at the end of each year for 12 years at 10.75% compounded annually
5.3 Part of the income that a machine generates is put into a sinking fund to replacethe
machine when it wears out. If $1,500 is deposited annually at 7% interest, howmany
years must the machine be kept before a new machine costing $30,000 canbe
purchased?
5.4 What equal annual payment series is required to repay the following presentamounts?
(a) $10,000 in 5 years at 5% interest compounded annually
(b) $5,500 in 4 years at 9.7% interest compounded annually
(c) $8,500 in 3 years at 2.5% interest compounded annually
(d) $30,000 in 20 years at 8.5% interest compounded annually
5.5 What is the present worth of the following series of payments?
(a) $800 at the end of each year for 12 years at 5.8% compounded annually
(b) $2,500 at the end of each year for 10 years at 8.5% compounded annually
(c) $900 at the end of each year for 5 years at 7.25% compounded annually
(d) $5,500 at the end of each year for 8 years at 8.75% compounded annually
5.6 You have borrowed $25,000 at an interest rate of 16%. Equal payments will bemade
over a three-year period. (The first payment will be made at the end of thefirst year.)
What will the annual payment be, and what will the interest payment befor the second
year?

6 Linear Gradient Series

6.1 An individual deposits an annual bonus into a savings account that pays 8%
interestcompounded annually. The size of the bonus increases by $2,000 each year,and
the initial bonus amount was $5,000. Determine how much will be in the
accountimmediately after the fifth deposit.

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6.2 An individual deposits an annual bonus into a savings account that pays 8%
interestcompounded
pounded annually. The size of the bonus increases by $2,000 each year,and
the initial bonus amount was $5,000. Determine how much will be in the
accountimmediately after the fifth deposit.

6.3 Compute the value of P in the accompanying

cash flow diagram, assuming
ming that
thati=9%

6.4 What is the equal payment series for 12 years that is equivalent to a payment seriesof
$15,000 at the end of the first year, decreasing by $1,000 each year over12 years?
Interest is 8% compounded annually.

7 Geometric Gradient Series

7.1 Supposee that an oil well is expected to produce 100,000 barrels of oil during itsfirst
year in production. However, its subsequent production (yield) is expected todecrease
by 10% over the previous year’s production. The oil well has a provenreserve of
1,000,000 barrels.
(a) Suppose that the price of oil is expected to be $60 per barrel for the nextseveral
years. What would be the present worth of the anticipated revenuestream at an interest
rate of 12% compounded annually over the next sevenyears?
(b) Suppose thatat the price of oil is expected to start at $60 per barrel during thefirst
year, but to increase at the rate of 5% over the previous year’s price. Whatwould be the
present worth of the anticipated revenue stream at an interest rateof 12% compounded
annuallyy over the next seven years?
(c) Consider part (b) again. After three years’production, you decide to sell the oilwell.
What would be a fair price?
7.2 What is the amount of 10 equal annual deposits that can provide five annual
withdrawalswhen a first withdrawal of $5,000 is made at the end of year 11 and
subsequentwithdrawals increase at the rate of 8% per year over the previous
year’swithdrawal if
(a) The interest rate is 9% compounded annually?
(b) The interest rate is 6% compounded annually?

8 Equivalence Calculations
8.1 Find the present worth of the cash receipts
were compounded annually.

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8.2 Find the equivalent present worth of the cash

receipts where In otherwords, how much do you
have to deposit now (with the second deposit in
theamount of $200 at thee end of the first year) so
that you will be able to withdraw$200 at the end
of second year, $120 at the end of third year, and
so forth if thebank pays you a 8% annual interest
on your balance?

8.3 What value of A makes two annual cash flows equivalent at 13%
13 interest
compoundedannually?

8.4 From the accompanying cash flow diagram, find the value of C
that will establishthe economic equivalence between the
deposit series and the withdrawal series atan interest rate of 8%
compounded annually

9 Solving for an Unknown Interest Rate or Unknown Interest Periods

9.1 At what rate of interest compounded annually will an investment double itself infive
years?

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9.2 Determine the interest rate (i)

( that makes the pairs of cash flows shown

economicallyequivalent.

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9.3 You have $10,000 available for investment in stock. You are looking for a growthstock
whose value can grow to $35,000 over five years. What kind of growth rateare you
looking for?
9.4 How long will it take to save $1 million if you invest $2,000 each year at 6%?

10 Short Case Studies

10.1 Fairmont Textile has a plant in which employees have been having trouble withcarpal
tunnel syndrome (CTS, an inflammation of the nerves that pass throughthe carpal
tunnel, a tight space at the base of the palm), resulting from long-termrepetitive
activities, such as years of sewing. It seems as if 15 of the employeesworking in this
facility developed signs of CTS over the last five years. DeepSouth,the company’s
insurance firm, has been increasing Fairmont’s liabilityinsurance steadily because of
this problem. DeepSouth is willing to lower theinsurance premiums to $16,000 a year
(from the current $30,000 a year) for thenext five years if Fairmont implements an
acceptable CTS-prevention programthat includes making the employees aware of CTS
and how to reduce thechances of it developing. What would be the maximum amount
that Fairmontshould invest in the program to make it worthwhile? The firm’s interest
rate is12% compounded annually.
10.2 Adidas will put on sale what it bills as the world’s first computerized “smartshoe.” But
consumers will decide whether to accept the bionic running shoe’s$250 price tag—four
times the average shoe price at stores such as Foot Locker.Adidas uses a sensor, a
microprocessor, and a motorized cable system to automaticallyadjust the shoe’s
cushioning. The sensor under the heel measures compressionand decides whether the
shoe is too soft or firm. That information is sentto the microprocessor and, while the
shoe is in the air, the cable adjusts the heelcushion. The whole system weighs less than
40 grams. Adidas’s computer-drivenshoe—three years in the making—is the latest
innovation in the $16.4 billionU.S. sneaker industry. The top-end running shoe from
New Balance lists for$199.99. With runners typically replacing shoes by 500 miles, the
$250 Adidascould push costs to 50 cents per mile. Adidas is spending an estimated $20
million on the rollout. The investment required to develop a full-scale commercial
rollout cost Adidas$70 million (including the $20 million ad campaign), which will be
financed at aninterest rate of 10%. With a price tag of $250, Adidas will have about
$100 netcash profit from each sale. The product will have a five-year market life.
Assumingthat the annual demand for the product remains constant over the market
life,how many units does Adidas have to sell each year to pay off the initial
investmentand interest?

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