discuss the following from Engineering Economy: 1. Do you use nominal or effecti

Question

discuss the following from Engineering Economy:

1. Do you use nominal or effective interest rates in the engineering economy factor formulas and tables? Why?

2. How do you know whether to use equation 4.2 or 4.7 to compute the effective interest rate? Give an example to illustrate.

Eq 4.2 is, Effective rate per CP = (r% per time period t) / (m compouding oeriod per t) = r/m

Eq 4.7 is, Effective i per time period = ((1+r/m)^m)-1

3. How do you know when you have to multiply one factor by another factor? Give an example.

4. Discuss the important rules involved when solving problems involving PP < CP. Give an example.

Explanation / Answer

1)

(i). I use effective interest rates in the engineering economy factor formulas and tables because.... Nominal and effective interest rates and continuous compoundingSince many real world problems involve payments and compounding periods which are not equal to oneyear, it is necessary to understand nominal and effective interest rates.If the compounding period is made infinitely small, interest is compounded continuously.All the engineering economy formulas require the use of effective interest rates only.In some instances there are several effective rates that can be used to solve the problem (such as whenonly single-payment amounts are involved).In other cases, only one effective rate can be used (Uniform series problems)For uniform series problems, the interest and payment periods must agree.

(ii).The difference is that nominal and effective interests are used whenthe compounding period (or interest period) is less than one year. Thus when an interest rate is expressedover a period of time shorter than a year, such as 1% per month, the terms nominal and effective interestrates must be considered.Nominalinterest rates must be converted into effective interest rates in order to accurately reflect time-valueconsiderations.Nominal interest rate, r, can be defined as the period interest rate times the number of periods. r = interest rate per period x number of periodsA nominal interest can be found for any time period which is longer than the originally stated period.

(iii)from period interest rates, the rate is called an effective interest rate. Effective rates can also bedetermined for any period longer than the originally stated period.All formulas derived are based on compound interest, and therefore, only effective interestrates can be used in the equations of formulas and tables.

FROM CHEGG RULES IT IS SUFFICIENT TO ANSWER 1ST QUESTION WHEN MORE THAN ONE QUESTIONS ARE IN SINGLE PAPER

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