Economics for Engineers PDF

## ECONOMICS FOR ENGINEERS ### Chapter at a Glance - **Economic Decision Making** - **Engineering Costs & Estimation** - **Cash Flow, Interest and Equivalence** - **Cash Flow & Rate of Return Analysis** - **Inflation and Price Change** - **Present Worth Analysis** - **Uncertainty in Future Events**...

## ECONOMICS FOR ENGINEERS ### Chapter at a Glance - **Economic Decision Making** - **Engineering Costs & Estimation** - **Cash Flow, Interest and Equivalence** - **Cash Flow & Rate of Return Analysis** - **Inflation and Price Change** - **Present Worth Analysis** - **Uncertainty in Future Events** - **Depreciation** - **Replacement Analysis** - **Accounting** **NOTE:** MAKAUT course structure and syllabus of 3rd semester has been changed from 2019. Previously ECONOMICS FOR ENGINEERS was in 5th semester. This has been redesigned and shifted in 3rd semester as per present curriculum. Subject organization has been changed slightly. Taking special care of this matter we are providing the relevant MAKAUT university solutions and some model questions & answers for newly introduced topics along with the complete solutions of new university papers, so that students can get an idea about university questions patterns. ## ECONOMIC DECISION MAKING ### Chapter at a Glance Decision Making is the selection of one curse of action from two or more alternatives courses of action. It is a choice making activity. **Role:** - It is a selective process. - It is a continuous process which goes on throughout the life of an organisation. - Decisions are normally taken on the basis of past experiences and present circumstances for a future course of action. ### Very Short Answer Type Questions 1. Which of the following statements is correct? - engineering economics provides a set of methods by which economic worth of alternatives can be compared - engineering economics never takes into account non-commercial considerations - engineering economics does not take into consideration tax liabilities of the firm - engineering economics is not applicable in the case of public sector undertakings 2. In decision making risk is measured by - expectation - mean - variance - median 3. The firm's decision to invest its funds in fixed and long term assets is known as - Assets Planning - Capital Budgeting - Long Term Budgeting - Short Term Budgeting 4. Which of the following is not applicable to bottom-up approach to cost estimation? - The project under consideration is considered at the highest aggregate level - The project under consideration is split into smaller parts and their respective components are identified - Cost estimates are made for each component of each small part and added up - Cost estimates are made for each component of each part of the project and are added up to arrive at the total ### Short Answer Type Questions **Discuss the economic problems faced by an engineer with suitable examples.** Answer: Some examples of engineering economic problems range from value analysis to economic studies. Each of these is relevant in different situations, and most often used by engineers or project managers. They are: - **Value Analysis:** Proper value analysis finds its roots in the need for industrial engineers and managers to not only simplify and improve processes and systems, but also the logical simplification of the designs of those products and systems. - **Linear Programming:** Is the use of mathematical methods to find optimized solutions, whether they be minimized or maximized in nature. - **Interest and Money: Time Relationships** Considering the prevalence of capital to be lent for a certain period of time, with the understanding that it will be returned to the investor, money-time relationships analyze the costs associated with these types of actions. Capital itself must be divided into two different categories, equity capital and debt capital. - **Depreciation and Valuation:** The fact that assets and material in the real world eventually wear down, and thence break, is a situation that must be accounted for. Depreciation itself is defined by the decreasing of value of any given asset, though some exceptions do exist. Valuation can be considered the basis for depreciation in a basic sense, as any decrease in value would be based on an original value. - **Capital Budgeting** in relation to engineering economics, is the proper usage and utilization of capital to achieve project objectives. It can be fully defined by the series of decisions by individuals and firms concerning how much and where resources will be obtained and expended to meet future objectives. ## ECONOMICS FOR ENGINEERS ### Chapter at a Glance - **Minimum Cost Formulas** being one of the most important and integral operations in the engineering economic field is the minimization of cost in systems and processes. Time, resources, labor, and capital must all be minimized when placed into any system, so that revenue, product, and profit can be maximized. - **Economic Studies**, both Private and Public in Nature, Economic studies, which are conducted from much indeterminate feasibility and utility of certain projects. They do not, however, reflect the "common notion of economic studies, which is fixated upon macroeconomics, something engineers have little interaction with. ### Long Answer Type Questions 1. **What is triangulation?** Answer: Triangulation involves two supplies of goods between three Value-Added Tax (VAT) registered traders in three different European Union (EU) Member States. For example, where a trader established in one Member State (MS1) sells goods to a trader established in a second Member State (MS2). The goods, however, are delivered to a trader in a third Member State (MS3). To reduce the administrative and compliance burdens on traders and the tax authorities associated with such triangular transactions there is a simplification measure. This simplification measure can only operate when the three traders involved are all registered for VAT in the European Union. In general, the simplification measure works as follows: - There is a zero-rated intra-Community supply (ICS) from company A to company B. - The supply is listed in the VAT information exchange system (VIES) return by company A to company B. - As company B has quoted its VAT number, it has made an intra-Community acquisition (ICA). Company B accounts for this ICA in its VAT return. - Company B makes a VAT-free supply to company C. Company C accounts for this transaction in its VAT return as a received supply. In this way company C is deemed to have accounted for company B's VAT liability in Member State 3. 2. **What are the steps involved in the rational decision making process?** Answer: Steps involved in Rational Decision Making Model are: - **Recognize the problem/opportunity**: In this phase, identify an opportunity or a problem that you want to solve. If it is a problem, identify the root cause of the problem. Do not mistake symptoms for problems. Example: Team members are missing deadlines. This is a symptom that is a result of either bad planning, unclear requirements or team members' lack of experience. - **Identify solution criteria**: Most of the time, we jump to solutions instead of identifying the solution criteria. To choose the best solution, come up with a list of criteria that the solution must meet. Example: The solution must be implemented in three months to meet the launch date, or should cost below a certain amount. Prioritize the criteria. - **Solutions exploration**: Analyze possible solutions that would fit the solution criteria. Do not stop with just one solution-explore multiple ones. - **Choose a preferred course of action**: In this step, evaluate all the solutions against each of the criteria that were identified in Step 2. Choose the solution that meets the most criteria. If there are multiple solutions that meet all the criteria, evaluate if there is a possibility to do a quick prototype or proof of concept of each of the solutions. This would uncover any pros/cons of the solutions that were missed in Step 3. - **Implement the preferred course of action**: The next step is to implement the chosen action. Ensure that any solution criteria that were defined upfront are indeed being met with this solution. - **Evaluate the results and follow up as necessary**: Lastly, evaluate the results. Ensure all the KPIs are being measured, and operationalize the solution. Do a lessons-learned or retrospective session to use them for subsequent decisions. ### Long Answer Type Questions 2. **a) What are the steps involved in the rational decision making process?** **b) What do you know about the unusual aspects of engineering decision making?** Answer: a) **Refer to question 2 a)** b) Engineering decision making often involves several unusual aspects compared to other fields due to its technical, ethical, and societal implications. Here are some key unusual aspects. - **Complexity and Interdisciplinary Nature**: Engineering decisions often require knowledge from multiple disciplines, such as mechanics, materials science, electronics, and computer science. Engineers must integrate these diverse fields to create viable solutions. - **Quantitative Analysis**: Engineers rely heavily on quantitative methods and models to analyze problems and predict outcomes. This includes the use of mathematical modeling, simulations, and statistical analysis. - **Optimization under Constraints**: Engineering problems typically involve optimizing solutions under various constraints, such as cost, time, materials, and regulatory requirements. Finding the optimal balance can be challenging. - **Risk and Uncertainty**: Engineering decisions must account for potential risks and uncertainties. This includes assessing the probability of failure, safety concerns, and potential environmental impacts. - **Ethical Considerations**: Engineers must consider the ethical implications of their decisions, ensuring that their solutions do not harm individuals or society. This includes adhering to safety standards and considering the long-term impact of the work. - **Iterative Process**: Engineering design and decision-making are often iterative processes. Solutions are developed, tested, and refined multiple times before final implementation. - **Stakeholder Involvement**: Engineers must often work with a variety of stakeholders, including clients, regulatory bodies, and the public. Effective communication and negotiation skills are essential to align different interests. - **Innovative Thinking**: Engineering solutions often require creative and innovative thinking to solve complex problems with unique constraints. - **Technical Feasibility and Scalability**: Decisions must consider the technical feasibility and scalability of solutions. Engineers need to ensure that their designs can be implemented on a larger scale and adapted to future needs. ## ENGINEERING COSTS & ESTIMATION ### Chapter at a Glance - **Variable cost:** The cost which tends to follow the level of activities is the variable cost. That is, variable cost is proportional with the level of output which might be expressed in terms of units, labour hours, machine hours. Example of variable cost might be direct material, direct labour, labour variable expenses (overhead). Here the word direct means variability and directly proportion to the production. These cost are also termed as activity cost. - **Fixed cost:** It is the cost which is fixed in nature irrespective of volume of production within the manufacturing capacity and is fixed for a certain period. It accrues in relation to the passage of time and which within certain output and turnover limits, tends to be unaffected by variation in the levels of output or turnover. It is also termed as Period Cost. - **Marginal cost:** It is the cost for producing one additional unit. This additional unit cost will be the variable cost because variable cost is incurred with every variation of output and fixed cost remains same. So the increase is only due to the variable cost. Marginal cost is useful for make or buys decision process. - **Average cost:** Average cost is the average cost per unit of production. It is ascertained as total cost of production for per unit of production. As in the above example the average cost would be For 1000 units produced = Rs. 6000/1000 units = Rs. 6 per unit For 1001 units produced = Rs.6005/1001 units = Rs. 5.99 per unit - **Sunk cost:** It is the cost which is already being incurred in past and is not relevant to any decision making process. e.g., Any survey or market research cost to decide whether any job to be undertaken or not is a sunk cost. - **Opportunity cost:** Opportunity cost is the benefit that could be derived from choosing any other alternative by utilizing the resources. It is also termed as foregone cost or opportunity loss. - **Recurring and non-recurring costs:** Recurring expenses are almost predetermined expenses which are incurred in regular intervals. These expenses part the predetermined expenses running the business process. e.g., salary expenses, repairs and maintenance operations. - **Incremental cost:** For any managerial decision making process of selecting between two or more alternatives it is required to have cost benefit analysis of different alternatives. - **Life-cycle cost:** In economic engineering analysis the assets are compared with the life of human beings, like growing through various phases, reaching maturity and ultimately declining termed as the life cycle. At every stages cost are associated for maintenance. Similarly every product and services produced also moves through phases in life cycle and each phase incurs various costs. It includes cost associated with acquiring, using, carrying, feasibility study, design and development, production, maintenance, replacement and disposal, support, training and operation. ### Types of Cost Estimate - Models - Per-unit Model - Segmenting Model - Cost Indexes Model ### Very Short Answer Type Questions 1. **Costs reflected in accounting system only are called** - Cash cost - Overhead cost - Book cost - Direct cost 2. **The opportunity cost of a good is** - the time last in finding it - the quantity of other goods sacrificed to the another unit of that good - the expenditure on the good - the loss of interest in using saving? 3. **To compute the construction cost per square foot of a building** - Per unit model will be used - Segmenting model will be used - Learning curve estimation process will be used - None of these 4. **Which one is fixed cost?** - Depreciation of fixed assets - Excise duty - Cost of advertising - Sales tax 5. **What is the relationship between Marginal cost (MC) and Average cost (AC) curves?** - AC cuts the MC from below - MC cuts the AC from below - AC and MC do not cut each other - there is no fixed relationship ### Long Answer Type Questions 1. **What is triangulation?** Answer: **Refer to question 1.** 2. **a) What are the steps involved in the rational decision making process?** **b) What do you know about the unusual aspects of engineering decision making?** Answer: **Refer to question 2.** 3. **Discuss the principles of Engineering Economy.** Answer: - **Principle-1: Develop the alternatives:** The choice (decision among alternatives, the alternatives need to be identified and then defined for subsequent analysis). - **Principle-2: Focus on Differences** Only differences in expected future outcomes among the alternatives are relevant to their comparison and should be considered in the decision. - **Principle-3: Use a consistent Viewpoint** The prospective outcomes of the alternatives, economic and other should be consistently developed from a defined view point (perspective). - **Principle - 4: Use a common unit of measure** Using a common unit of measurement to enumerate as many of the prospective outcomes as possible will simplify the analysis of the alternatives - **Principle-5: Consider All Relevant Criteria** Selection of a preferred alternative (decision making) requires the use of a criterion or several criteria). The decision process should consider both the outcomes enumerated in the monetary unit and those expressed in some other unit of measurement or made explicit in a descriptive manner. - **Principle - 6: Make risk and Uncertainty Explicit** Risk and uncertainty are inherent in estimating the future outcomes of the alternatives and should be recognized in their analysis and comparison. - **Principle-7: Revisit Your Decisions** Improved decision making results from an adaptive process, to the extent practicable, the initial projected outcomes of the selected alternatives should be subsequently compared with actual results achieved.. ## INFLATION AND PRICE CHANGE ### Chapter at a Glance - **Inflation** may be defined as a general rise in the prices in a persistent manner. It causes a loss in the purchasing power of a currency. It happens when many prices increase simultaneously. Inflation causes money to loose purchasing power. What a rupees hundred can buy today will be less in coming in coming days. Thus the rupee hundred looses the purchasing power due to the price rise, that is inflation. In engineering economic analysis it requires cost benefit analysis of any investment that requires comparison be made on a equivalent basis. On the contrary, when the purchasing power increase the situation is deflation. But this situation does not exist. - **Control of inflation:** There is no single remedy to combat the inflation rather monetary and non-monetary fronts rare to be considered to have control on it. The aim is to reduce aggregate monetary expenditure. Anti-inflammatory measures can be classified as: - **Monetary measures:** The best remedy for fighting inflation is to reduce the aggregate spending. Monetary policy can help in reducing the pressure on demand by increase cost of borrowing from banks thus reducing the demands for funds. - **Fiscal measures:** It includes spending both in private and government level. Government reduces expenditures and private expenditure is reduced increasing tax. - **Physical and non-monetary measures:** Measures like increasing output imports, decrease exports so as to increase the available supply of goods in short supply so as to bring the demand and supply at parity and thus the prices tend to be control. - **Price changes with indexes:** The term "inflation" refers to a rise in a broad price index representing the overall price level for goods and services in the economy. Inflation is measured by price index numbers. As we know, a price index measures the general level of prices in reference to some base period. The Consumer Price Index (CPI), the Personal Consumption Expenditures Price Index (PCEPI) and the GDP deflator are some examples of broad price indices. "inflation" may also be used to describe a rising price level within a narrower set of assets, goods or services within the economy, such as commodities (including food, fuel, metals), tangible assets (such as real estate), financial assets (such as stocks, bonds), services (such as entertainment and health care), or labour. The Reuters-CRB Index (CCI), the Producer Price Index, and Employment Cost Index (ECI) are examples of narrow price indices used to measure price inflation in particular sectors of the economy. ### Long Answer Type Questions 9. **a) A firm expanded one of its manufacturing operations inside an existing building. New processing and packaging equipment was purchased for $800,000. Sales revenue for the year was $1.25 million. Operating expenses for that year, not including the capital expenditures, were $360,000. The new equipment qualifies for 100% bonus depreciation. (i) What is the first-year depreciation charge? (ii) What is the first-year taxable income? (iii) What are the federal income taxes for the year?** **b) Illustrate the model of a Balance sheet.** Answer: a) - Sales revenue $ 12,50,000 - Operating expenses ($ 3,60,000) - Income before depreciation $ 8,90,000 - Depreciation (100%) ($ 8,90,000) - Taxable income/Net Income before depreciation Nil - Income tax Nil b) **Refer to question 8 b)** ## PRESENT WORTH ANALYSIS ### Chapter at a Glance - **End of the year convention** In the above the basic assumption taken as the receipt or disbursement is generally taken to be in the end of any year. Like if and project yields and revenue it is assumed to be in the end of next year. This is known as End of the Year Convention. This convention is used for considering the time value of money for preparation, the present worth (value) factor table or for compound interest factors e.g. As the compound interest formulae as derived is, A=Px[1+i]n where A is the Future value of money invested at the end of the year (1, 2, 3............n) P = Principal amount invested or value of money at t = 0 i = Rate of return / Rate of return/ Cost of Capital for financing any project. Here [1+i]n is the interest rate factor - **Major Areas of Analysis - Economic view point** - **Borrowed money view point:** Any investment requires a lot of funds to be invested at the beginning of even at in between the project life. This investment is required to be financed from various sources. The financing do incurs cost and is a vital factor for capital budgeting analysis. Thus we get an interest rate for financing which is used to determine the time value of money for the Present worth analysis. From the above compound interest formulae we can get P = Ax 1 / [1+i]n Here, P = Present worth [Present value] of money. [Cash inflow from the investment made at present time] A = Returns/cash inflow in the nth year i = is the interest rate or cost of borrowing for the financing. Here, 1 / [1+i]n is the Present worth/ Discounting rate factor. - **Inflation and deflation:** Using of proper present worth rate / discount rate depends on whether the benefits and costs are measured in real or nominal terms. To be consistent and free from inflation bias, the cash flows should match with discount rate. This equivalence value means that an asset what cost today a certain sum of money can be expected to cost the same amount several years hence for the purpose analysis. - **Taxes:** Tax is incorporated in the present worth analysis as the future return of cash inflow is after adjustment of tax. But it is assumed in a present worth analysis, done at present (t=0), tax rate to be kept constant for the purpose of analysis only. - **Depreciation:** Depreciation is the loss due to wear and tear of the purchased asset in use. It is used to calculate as to determine the cash flow after charging depreciation and tax. As per tax rules tax is-applicable on profit after charging depreciation. ### Very Short Answer Type Questions 1. **Contribution margin is the** - excess of sale price over variable costs - excess of sale price over fixed costs - excess of sale price over both variable and fixed costs - none of these 2. **What is the full form of PVIF?** - Present Value Income Factor - Present Value Interest Factor - Profit Value Income factor - None of these 3. **If actual sales are Rs. 40,000 and BEP sales are Rs. 30,000, the Margin of Safety is Rs.** - 70,000 - 10,000 - 1,40,000 - 15,000 4. **FVIF 5%, 3 =** - 1.050 - 1.103 - 1.158 - 1.216 5. **In NPV method, cash flow is generally calculated on the basis of** - present value - future value - annuity - none of these 6. **What could be the value of present sum for Rs. 10,000 at 8% interest for one year?** - Rs. 9,263 - Rs. 9,261 - Rs. 9,264 - none of these ### Short Answer Type Questions 1. **Define Break even point. Represent the elements diagrammatically, and derive the BEP and BEP sales algebraically.** **b) The following data relates to ABC Co. for 2011: Fixed Factory Overhead = Rs. 30,000 Fixed Selling Overheads = Rs. 6,000 Variable Manufacturing Cost per unit = Rs. 6.00 Variable Selling Cost per unit = Rs. 1.50 Selling Price Per unit = Rs. 12.00 Calculate i) Break-even point in terms of units and BE sales in terms of rupees. ii) Number of units that need to be sold to make a profit of Rs. 45,000.** Answer: a) **Break-even-point is that level of sales at which total cost and total revenue will be in equilibrium, i.e.. it is that level of sales at which there is neither profit nor less. If actual sales exceed Break-even-sales, then, there is profit but if actual sales are less than break-even-level of sales, then, there is loss.** b) i) **BEP(units)=** ``` Fixed cost Contribution (per unit) = Fixed Factory Overhead + Fixed selling overhead Selling price (per unit)-Variable cost per unit = 30,000+6,000 = 36,000 = 8,000 units 12-(6+1.50) 12-7.50 4.50 ``` **BEP (Rs.) = Fixed cost** ``` Fixed cost p/vratio Contribution (per unit) Selling price(per unit) = 36,000 36,000×12 = 96,000 Rs. 4.50 4.50 ``` ii) **No. of units needed to be sold to make profit of Rs. 45,000** ``` Target profit+Fixed cost Contribution (per unit) = 45,000+36,000 81,000= 18,000 units 4.50 4.50 ``` ## REPLACEMENT ANALYSIS ### Chapter at a Glance - **Replacement Analysis:** Replacement analysis is the systematic and economically evaluating decisions of either retaining the existing asset/'equipment or acquiring new equipment by replacing the existing equipment. The existing facility is the termed as defender and that of replacing the existing facility by choosing the best course of action among the alternative available is the challenger. Replacement Analysis deals with evaluation of defender and challenger. Various replacement analysis techniques are applied depending different circumstances for existing installed asset / defender against the best current available asset / challenger. - **Decision mapping:** A replacement analysis decision map can be expressed in flow char diagram for ease in decision making. - **Minimum Cost life Analysis:** The minimum cost life of any new asset is the years at which the EUAC is minimized. This cost life should be lesser than the actual / physical life of an asset, due to the increase of operating & maintenance cost in the later years of asset. - **Generally cost of operation & maintenance of a machine increases due to passage of time.** - **The replacing machine [defender] time should be fixed.** - **Replacement policy for gradual deterioration.** - **Salvage value to be determined prior to the decision making.** - **Time value of replacing asset** As discussed the replacement decision would be at which the EUAC is minimum. This calculation can be made in two aspects. ``` EUAC = Price of equipment - value of machine after life [i.e., salvage value] + Maintenance cost for the years ``` - **Defender** refers to the existing facility. ## ACCOUNTING ### Chapter at a Glance - **Accounting** is means of communicating the results of the business operation to various parties interested in or connected with the business, like owner, creditors, government, financial institution and other parties. This is done by systematic recording of the events and transactions as per accounting process guidelines, principles and forms. The American Accounting Association defines accounting as the "Process of identifying, measuring and communicating economic information to permit informed judgments and decisions by the user of the information." - **Balance Sheets:** It is a statement of financial position consisting of assets and liabilities of any business enterprise in a particular date. Balance sheet summarises and reveals the financial position on an enterprise. Balance sheet is prepared following few concepts like - Money Measurement Concept, Entity Concept Cost Concept and dual aspect concept. The basic equation followed is, Assets = Liabilities + Owner's Equity - **Ratio analysis:** Ratio analysis is one of the techniques of financial analysis to evaluate the financial condition and performance of a business concern. Ratios are calculated from current year numbers and are then compared to previous years, other business, the industry, or even the economy to judge the performance of the business. ### Long Answer Type Questions 1. **a) What do you understand by replacement analysis? Explain 'Economic life' of an asset. **b) A firm has purchased an equipment at Rs. 20,000. When should the asset be replaced, if the following is given.** Answer: a) **Refer to question 1 a)** b) **Refer to question 1 b)** ## DEPRECIATION ### Chapter at a Glance - **Depreciation** is the decrease in value of physical properties with the passage of time and use. More specifically Depreciation is an accounting concept that establishes an annual deduction against before - tax income such that the effect of time and use on an asset's value can be reflected in a firm's financial statements. - **Depreciation** is noncash cost that is intended to match the yearly fraction of value used by an asset in the production of income over the asset's life. The actual amount of depreciation can never be established until the asset is retired from service. Because depreciation is a noncash cost that affects income taxes, we must consider it properly when making after-tax engineering economy studies. - **Meaning of Depreciation:** On the basis of Fundamental Accounting Assumption of Going Concern, assets are classified as Fixed Assets and Current Assets. Fixed assets are used in the business to drive benefits for more than one accounting period. Periodic profit is measured by charging cost against periodic revenue. Since fixed assets are used to generate periodic revenue, an appropriate proportion of the cost of fixed assets, which is believed to be used or expired for generation of periodic revenue, needs to be charged as cost. Such an appropriate proportion of the cost of fixed assets is termed as Depreciation. Generally, the term 'depreciation' is used to denote decrease in value but in accounting, this term is used to denote decrease in the book value of a fixed asset. Depreciation is the permanent and continuous decrease in the book value of a fixed asset due to use, efflux of time, obsolescence, expiration of legal rights or any other cause. ### Straight line method of depreciation: - **Step. 1: Amount of Depreciation = (Original cost less Residual value) / Expected useful life of the asset** - **Step. 2: Rate of Depreciation = (Amount of Depreciation / Original Cost) x 100** ### Written Down Value Method (WDV) In this method rate of depreciation falls on WDV of the assets and the rate of depreciation is calculated by the following formula: ``` r=1- S C ``` where r = W.D.V rate of Depreciation S = Salvage value C = Original cost of the asset. ### Long Answer Type Questions 1 **a) Explain the types of property in the context of Depreciation. b) 'Almost al tangible property can be depreciated'. - Explain. c) 'One important exception is land, which is never depreciated'. - Explain. d) What is the meaning of "Obsolescence?** Answer: - **Refer to question 1)** 2. **How can GST give relief to the overall tax burden?** Answer: The Goods and Services Tax (GST) can give relief to the overall tax burden by streamlining and simplifying the tax structure, promoting efficiency, and reducing the cascading effect of taxes. Here's how GST can provide such relief: - **GST consolidates all these taxes into a single tax system, reducing the complexity and administrative burden of managing multiple tax structures.** - **GST is designed to be a single, comprehensive tax levied on the supply of goods and services from the manufacturer to the consumer. Credits of input taxes paid at each stage are available in the subsequent stage of value addition, which eliminates the cascading effect of taxes, thus reducing the overall tax burden.** - **Businesses can claim input tax credits for the GST paid on purchases, which can be offset against the GST collected on sales. This reduces the effective tax rate on the final product and lowers costs, benefiting both businesses and consumers.** - **A unified tax system with a single registration, filing, and payment process simplifies compliance, reducing administrative and compliance costs for businesses.** ## CASH FLOW, INTEREST AND EQUIVALENCE ### Chapter at a Glance - **Time value of money:** It is known to all that Rs. 100 on hand now is more valuable than Rs. 100 receivable after one year. Differently speaking, we will not part with Rs. 100 now in return for a firm assurance that the same sum will be repaid after a year. But we might part with Rs. 100 now if we are assured that something more than Rs. 100 will be paid at the end of the first year. This extra compensation required for parting with Rs. 100 now is called 'interest' or the time value of money. - **Money has time value for the following reasons:** - Money can be employed productively in order to generate real returns. e.g., if Rs. 100 is invested in material and labour produces finished goods worth Rs. 105, we can say that the investment of Rs. 100 has earned a return of Rs. 5 per cent. - During inflation, value of a rupee today is more (higher purchasing power) than a rupee in future. - As because future is uncertain, people like current consumption more than future consumption. - **Effective vs. Nominal Rate of Interest:** The general relationship between the effective and nominal rates of interest is as follows: ``` [1+ (r/m)]m – 1 = ``` where, r = Effective rate of interest k = Nominal rate of interest m = Frequency of compounding per year. ### Very Short Answer Type Questions 1. **A person if deposits Rs. 50,000 in a bank at an interest of 10% compounded annually, then the future value at the end of 5 years will be** - 80,525 - 70,525 - 85,525 - 90,525 2. **A deposit of Rs. 1,10,000 was made for 31 days. The net interest after deducting 20% withholding tax is Rs. 890.36. Find the rate of return annually.** - 12.25 - 12.75 - 11.75 - 11.95 3. **The present value of ₹ 1 to be received after 3 years compounded annually at 10%** - 0.909 - 0.826 - 0.751 - None of these 4. **A uniform series of payment occurring at equal interval of time is called** - Annuity - Amortization - Depreciation - Bond 5. **What do you mean by Cash-flow diagram?** Answer: Cash flow diagrams visually represent cash inflows and cash outflows over some time interval. The diagram consists of a horizontal line with markers at a series of time intervals. 6. **The cash flows method, utilized by the internal rate of return and net present value method is known as** Answer: Discounting Method 7. **Time value of money theory describes money received in the current time which is more valuable than money received in future. (True/False)** Answer: True ## CASH FLOW & RATE OF RETURN ANALYSIS ### Chapter at a Glance - **Net Present Value (NPV) Method:** In this method all cash flows attributable to a capital investment projects are discounted by a chosen percentage e.g. the firms weighted average cost of capital to obtain the present value of the future cash flows. If the present value of the future cash flows is higher than the present value of the investments the proposal is accepted else rejected. In order to arrive at the net present value the present value of the future cash flows is deducted from the initial investment. ``` NPV = C₁/(1+K)¹ + C₂/(1+K)²+ C₃/(1+K)³ + .....+ Cn/(1+K)n - C₀ i.e., NPV = ΣCt / (1+K)t - C₀ ``` where C₀ = initial investment (cash out flows) Ct = cash inflows occurring at time t K = Discount rate. - **Profitability Index Method (PI) / Benefit Cost Ratio (BCR):** Another time adjusted method of evaluating the investment proposals is the Benefit Cost (B/C) ratio or Profitability Index (PI). Profitability Index is the ratio of the present value of cash inflows at the required rate of return, to the initial cash outflow of the investment. The formula for calculating benefit cost ratio or profitability index is as follows: ``` PI = PV of cash flows/Initial cash outlay = PV(C)/C₀ ``` - **Internal rate of return method:** Internal rate of return is a percentage discount rate used in capital investment appraisals which makes the present value of the cost of the projects equal to the future cash flows of the project. It is the rate of return which equates the present value of anticipated net cash flows with the initial outlay. The IRR is also defined as the rate at which the net present value is zero. The test of profitability of a project is the relationship between the internal rate of return (%) of the project and the minimum acceptable rate of return. The IRR can be determined by solving the following equation for r which is discount rate. ``` Co = C₁ / (1+r)¹ + + C₂ (1+