In these “Construction Finance” articles, we will analyze the finance of civil engineering and construction management. The first few articles cover mathematics, specifically the time value of money, interest rates, and rate of return. The second set of articles will be about real estate finance. And finally, the last set will explain public-private partnership financing and the associated risks.
Time Value of Money
What is the time value of money? In terms of the construction industry, the time value of money, which can also be called the math of money, is the payment of interest in exchange for the use someone else’s money over a certain period of time.
The simple, and most important, concept to learn about the time value of money is that a unit of currency received today not equal to the same unit of currency received in the future. For example, 20 dollars today does not have the same buying power as 20 dollars ten years from now. When comparing costs or earnings at differing periods of time, you cannot simply add the two amounts of money together.
Construction firms acquire funds by borrowing it from banks, financial institutions, or other lending sources. The cost of borrowing this money, and the length of time it is borrowed, are vital factors in every civil engineering business decision. Learning the time value of money is essential in evaluating whether or not a construction project is worthwhile.
What is project evaluation? Project evaluation is when a construction manager has a potential project and wishes to know if it feasible to invest time and money in competing it.
If given a list of projects, project evaluation will help determine which is the most feasible. If completing several projects, project evaluation is instrumental in prioritizing the list and determining how to rank each project compared to the others.
In essence, we are evaluating construction investments and the use of money, whether it is our money or borrowed money.
For example, let’s say we need a piece of construction equipment for several upcoming projects. Does it make more financial sense to buy the equipment outright or lease it on a monthly basis?
Here’s another example that a construction manager may face. There are two construction projects, Project A and Project B. Project B will take twice as long to build as Project A, however the cost of $10000 per month is the same for both. If the value of completing Project A is $250000 and the value of completing Project B is $400000, what is the total profit gained for each project? What is the total cost for each project? If we can only complete one of the two projects, which one should be undertaken?
Future articles will address these and other example project evaluations.