Page 245 - Plant design and economics for chemical engineers

CHAPTER

INTERESTAND
INVESTMENT

COSTS

A considerable amount of confusion exists among engineers over the role of
interest in determining costs for a manufacturing operation. The confusion is
caused by the attempt to apply the classical economist’s definition of interest.
According to the classical definition, interest is the money returned to the
owners of capital for use of their capital. This would mean that any profit
obtained through the uses of capital could be considered as interest. Modern
economists seldom adhere to the classical definition. Instead, they prefer to
substitute the term return on capital or return on investment for the classical
interest.
Engineers define interest as the compensation paid for the use of borrowed
capital. This definition permits distinction between profit and interest. The rate
at which interest will be paid is usually fixed at the time the capital is borrowed,
and a guarantee is made to return the capital at some set time in the future or
on an agreed-upon pay-off schedule.

TYPES OF INTEREST
Simple Interest

In economic terminology, the amount of capital on which interest is paid is
designated as the principal, and rate of interest is defined as the amount of
interest earned by a unit of principal in a unit of time. The time unit is usually
taken as one year. For example, if $100 were the compensation demanded for

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