Transcript day 14 - finance and ethics

Engineering is
$$$
A dollar today is worth more than a dollar tomorrow:
Compound Interest
P0 = principal 0 time units into the future (i.e., today)
Pn = principal n time units into the future
Pn  P0 1  r 
n
where r is the annual
interest rate
A dollar today is worth more than a dollar tomorrow:
Present Value:
P0  Pn 1  r 
where r is the annual interest rate
US treasury bills sold at
“discount”, so that when the bill
matures, you receive face value.
If you buy a one-year $10,000
bill with an interest rate of 3%,
how much should you expect to
pay for it?
n
A dollar today is worth more than a dollar tomorrow:
Effective Interest:
1
n
 Pn 
r     1
 P0 
Invest $10,000 in company stock. Ten years later, you sell
the stock for $20,000. What was your effective annual rate of
return?
Compound interest—different forms
Interest compounded
once per year
Interest compounded
q times per year
Pn  P0 1  r 
n
 r
Pn  P0 1  
 q
nq
Interest compounded
continuously
nq
 r
Pn  P0 lim 1    P0e rn
q 
 q
A Dutchman Peter Inuit bought Manhattan from the
Canarsie Indians for $23 in 1626. Who got robbed. . .?
 r
Pn  P0 1  
 q
nq
Assuming funds were invested at 6% compounded monthly
since 1626. The investment today would be worth
$23*(1+.06/12)(12*(2010-1626)) = $220 *109
DJIA 1900-2010
Lease vs. Buy?
Example: Honda Pilot EX AWD price = $33,595
(Chicago, 2006 figures)
Purchase with 20% down and a 36 month loan @6.75%
down payment
monthly payment
spent after 36 mo
residual value
total cost
= $ 6,719
= $ 825
= $36,419
= $23,701
= $12,718
Lease for 36 months
down payment
monthly payment
spent after 36 mo
residual value
total cost
= $ 2,000
= $ 359
= $14,565
= $0
= $14,565
Annuities: Equal payments paid (or received)
over n time periods
Future value of an annuity:
Pn  P[(1  r ) n 1  (1  r ) n  2  (1  r )1 ]
where Pn = the value of the annuity after n payments of P
Multiply both sides by (1+r) to obtain
Pn (1  r )  P[(1  r ) n  (1  r ) n 1  (1  r ) 0 ]
Subtract the first equation from the second to obtain
[(1  r ) n  1]
Pn  P
r
Annuity example: Each year for 20 years you
deposit $1000 into an annuity at an interest rate of
5%. What will be its value in 20 years?
[(1.05) 20  1]
An  $1000 *
 $33065
.05
Annuity example: You win $1M in a lottery which pays
you in 20 annual installments of $50K? What’s it worth $$
today, i.e., what is its present value? Assume 5% interest.
[(1  r ) n  1]
Pn  P
r
but,
So,
Pn  P0 1  r 
n
[(1  r ) n  1]
1.0520  1
P0  P
 $50K
 $623K
n
20
r (1  r )
.05 * (1.05)
Opportunity Cost
The opportunity cost of a decision is based on what must be given up (the
next best alternative) as a result of the decision. Any decision that
involves a choice between two or more options has an opportunity cost.
Applications of Opportunity Cost
The concept of opportunity cost has a wide range of applications including:
Consumer choice
Production possibilities
Cost of capital
Time management
Career choice
Analysis of comparative advantage
Payback Period
The length of time required to recover
the cost of an investment.
Shorter paybacks are better investments.
Problems with this metric:
1. It ignores any benefits that occur after the payback
period and, therefore, does not measure profitability.
2. It ignores the time value of money.
Identity
• Your name
–
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Single most important asset that you own
Permanent – it follows you through your life
Important in all societal interactions
Attached to every personal achievement and
failure
Ways to enhance this asset
•
•
•
•
•
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•
Honesty
Reliability
Competence
Truthfulness
Consistency
Fair Play
Education
Things to tarnish this asset
•
•
•
•
•
Dishonesty
Cheating
Trickery
Criminal Activity
Unethical Behavior
Social Security Number
• Second most important asset you own
• Permanent
• Important in almost all activities involving
money
–
–
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Taxes
Credit cards
Retirement Benefits
Medical Records
Where you live
• Used by insurance companies to determine
rates
• Used by state governments to establish
property tax rates
• Suggests social status
• Determines educational opportunities for
public K-12 schools
Other Identity Influences
• Who you know
• Where you went to school
Ethics
• Moral Principles or values
• Code of Conduct
• Recognition of “good” or “right” vs. “bad” or
“wrong”
• System or code of morals for a religion, group or
profession
• Personal code of conduct based on respect for one’s
self, others, and one’s surroundings
• A set of principles and values that govern behavior to
accord with a notion of morality
Legal vs. Moral
• Laws attempt to define unambiguous,
enforceable rules that parallel a culture’s
morality
• Money muddies the waters of legal vs. moral.
Corporations/Companies
• Identity independent of those who run the
company
• Trademarks, Intellectual property are corporate
assets
• Unlike personal reputations, can erase
problems by dissolving and reforming
• The bottom line – money
• Short term vs. long term views
You have borrowed a knife from a friend who,
since has turned homicidal. He wants it
returned. On the one hand you have a moral
obligation to return what you have borrowed.
On the other hand you have a moral obligation to
protect those around you.
Dilemma posed by Plato in The Republic
As a medical representative for a friend who lays
dying in the hospital, you are asked whether you
want life support removed. Your friend could
live indefinitely in a coma with support, but
would die within 24 hours without it. Hospital
costs are $1000/day. You know that both
yourself and several other friends are named in
his will.
An energy corporation must be responsive to its
stockholders. Extracting coal using strip mining
is clearly most profitable, but the terrain will be
permanently compromised. Shaft mining is
much less profitable, but will preserve the
landscape.
A family is 6months behind in paying its rent
(husband lost job, child became critically ill).
Landlord has the legal right to evict.
An engineering firm has won an award to build a
bridge to specification for a set price. Due to
misestimating costs, if the firm builds the bridge
as specified the company will go bankrupt.
However, if the firm uses inferior materials and
reduces the safety factor in the bridge design, it
can make a profit.
An automobile manufacturer discovers a
significant design flaw in a new model that,
under the right circumstances, could cause the
car to flip at high speed. But the chances are
slim. Issuing a recall would be very expensive
and would probably negatively affect future
sales. Ignoring the flaw and hoping that
resulting accidents could be blamed by driver
error would save profits and the model line.