MEC600

Chapter 1

Financial Management

Financial Management ?????

LEARNING OUTCOMES At the end of the lecture, participants should be able to: 1.Identify the main concept of time value of money and cost of capital. 2.Explain the discounting method for investment capital 3.Explain depreciation and capital allowances applied in financial planning 4.Understand the concept of cash flow 5.Understand company reports and Profit and Loss Statement 6.Capable of handling Balance Sheet calculation/tabulation.

Objective To introduce participants to the idea of what financial management is all about.

Individual: knowledge of nance in order to make personal decisions.

Professional: in important business decisions which requires engineers understanding and in-depth analysis towards nancial implication.

Importance of Financial Management

Compare & contrast

Why Is Engineering Economics Important?

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Engineers DESIGN things and perform PROJECTS

Therefore, engineers must be concerned with the economic aspects of designs that they recommend, and projects that they perform

What can go wrong when we dont have the concepts of engineering economics?

What Kinds of Ques0ons Can Engineering Economics Answer?

Engineering economics is needed for many kinds of decision making Example: Buying a bike

Alternatives: $85,000 now, or $1,600 per month for 6 years

Which is better?

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Engineering Economics Helps Make Cash Flow Comparisons!

Example: Buying a car Alternatives:

RM85,000 now, or RM1,600 per month for 6 years (= RM115,200 total)

Which is better? It depends!

Issue: how much is money now worth compared to money in the future?

Leads to idea of time value of money!

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Time Value of Money (TVM) The idea that a dollar today is worth more than a dollar in the future, because the dollar received today can earn interest up until the time the future dollar is received.

(Copyright 2004, Campbell R. Harvey.)

Time value of money deals with changes in the value of money over some period of time (due to investment opportunities, uncertainty, etc.)

This is the single most important concept in engineering economics!

Key Concept: Time Value of Money? Example; Would you rather have:

RM100 today, or RM100 a year from now?

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Time Value of Money Would you rather have:

RM100 today, or RM100 a year from now?

Basic assumption: Given a xed amount of money, and A choice of having it now or in the future,

Most people would prefer to have it sooner rather than later

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Time Value of Money Basic assumption:

Given a xed amount of money, and A choice of having it now or in the future, Most people would prefer to have it sooner

Reasons: ? ? ? ?

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Time Value of Money Basic assumption:

Given a xed amount of money, and A choice of having it now or in the future, Most people would prefer to have it sooner rather than later

This assumption is not universally satised: E.g., saving money for graduate school

But it is nearly universal, especially in business

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Time Value of Money One consequence of the time value of money:

Suppose you are willing to exchange a certain amount now for some other amount later

Then the later amount has to be ________________?

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Time Value of Money

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The time value of money centers around the idea of an interest rate (if projecting into the future):

Or, equivalently, a discount rate (if rolling back to the present)

Time value of money deals with changes in the value of money over some period of time (due to investment opportunities, uncertainty, etc.)

This is the single most important concept in engineering economics!

Time value of money results from the concept of interest.

What Does This Mean for Us? In this course, we will learn methods to:

Compare dierent cash ows over time Using the interest rate or discount rate:

How much more a dollar today is worth, Compared to a dollar in one year

For example, if the interest rate is 5%: RM100 today is worth as much as RM105 next year

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Illustra0on of Discoun0ng

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What Kinds of Ques0ons Can Engineering Economics Answer?

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It will help you make good decisions in:

Professional life (Regardless of whether you go into the private or public sector)

Personal life! Knowledge of engineering economics will have a signicant impact on you personally!

What Kinds of Ques0ons Can Engineering Economics Answer?

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ENGINEERING ECONOMICS INVOLVES:

FORMULATING, ESTIMATING, AND EVALUATING (F2E)ECONOMIC OUTCOMES

WHEN CHOICES OR ALTERNATIVES ARE AVAILABLE

How Does It Do This?

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BY USING SPECIFIC

MATHEMATICAL RELATIONSHIPS

TO COMPARE THE CASH FLOWS OF THE DIFFERENT ALTERNATIVES

(typically using spreadsheets)

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Here is an approach to problem-solving:

Understand the problem Collect all relevant data/information Dene the feasible alternatives Evaluate each alternative Select the best alternative Implement and monitor the decision

Where Does Engineering Economics Fit?

Where Does Engineering Economics Fit?

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1. Understand the Problem 2. Collect all relevant data/information (dicult!) 3. Dene the feasible alternatives 4. Evaluate each alternative 5. Select the best alternative 6. Implement and monitor

This is the major role of engineering economics

Where Do I Get the Data?

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Engineering economics is based mainly on estimates of future costs and benets:

So it has to deal with risk and uncertainty The costs, benets, and other parameters are typically unknown, and can vary over time:

The values of these parameters will dictate a particular numerical outcome

And therefore a particular decision! Sensitivity analysis can be used to explore how the decision changes as our estimates change

What If I Dont Like the Answers?

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Remember: Tools dont make decisions People make decisions, based on values

Engineering economics is just a set of tools: It can help in decision making But it wont make the decision for you

Which alternative is best is up to you!

LEARNING OUTCOMES

At the end of the lecture, participants should be able to: 1.Identify the main concept of time value of money.