ENGINEERING

ECONOMY
Engr. Jeremias Jr. Yang Marquez
ENGINEERING ECONOMY
– the analysis and evaluation of the factors that will affect the economic
success of engineering projects to the end that a recommendation can be
made which will ensure the best use of capital.
SIMPLE INTEREST – the interest on a loan that is based only on the principal.
Usually used for short-term loans where the period is measured in days rather
than years.
I = Pin
F = P + I = P + Pin
F = P(1+in )
where:
I = interest
P = principal or present worth
n = number of interest periods
i = rate of interest per interest period
F = accumulated amount or future worth
TYPES OF SIMPLE INTEREST

ORDINARY SIMPLE INTEREST - interest is computed on the basis of 12

months of 30 days each which is equivalent to 360 days a year. In this case,
the value of n that is used in the preceding formulas may be computed as:
where d is the number of days the principal was invested
EXACT SIMPLE INTEREST – interest is computed based on the exact number
of days in a given year which is 365 days for a normal year and 366 days during
a leap year (which occurs every 4 years, or if it is a century year, it must be
divided by 400). Note that during leap years, February has 29 days and 28 days
only during a normal year. In this case, the value of n that is used in the
preceding formulas may be computed as:
SIMPLE INTEREST AND DISCOUNT
1. Determine the future worth on P10,000 for 9 months and 15 days if the rate of ordinary
simple interest is 6%.
SOLUTION:
I = Pin
Solving for the number of days:
d = (9 X 30) + 15 = 285 days
I = (10,000)(0.06)( 285/360) = P475

F = P + I = 10,000 + 475 = P 10, 475

Or F = P(1 + in) = 10, 000(1 + [0.060(285/360)] = P 10, 475

2. Determine the exact simple interest on P20,000 for the period from January 15 to
November 15, 2012 if the rate of simple interest is 5%.
3. You loan from a bank the amount of P100,000 with a rate of simple interest of 20%
but the interest was deducted from the loan at the time the money was borrowed. If
at the end of 1 year, you have to pay the full amount of P100,000, what is the actual
rate of interest?
 A cigarette vendor borrowed P2400 and agreed to pay
P3000 after 30 days. What is the simple interest rate per
annum?

SOLUTION:
0 30 F = P(1 + rt)
é r(30) ù
3000 = 2400 ê1 + ú
P=2400 F=3000
ë 360 û
r =3
r = 300%
A certain sum of money will be deposited in a savings account that pays interest at
the rate of 6% per year, compounded annually. If all of the money is allowed to
accumulate, how much must be deposited initially so that $5000 will have
accumulated after 10 years? (Single payment present worth factor = 0.5584)

Solution:
In 1940, the average value of a house is P290, 000. In 1990, the average value
of a house of the same model is P7, 910, 000. What was the rate of inflation for
the house?

SOLUTION:

F = P(1 + i)n
7,910,000 = 290,000 (1 + i)50
(1 + i)50 = 27.27586
i = 6.8%
What rate of interest compounded monthly is equivalent to an
interest rate of 14% compounded quarterly?
SOLUTION:

For the rate of interest to be equal, their effective rate must be equal.
𝑟 𝑛
ERI = (1 + 𝑚
) -1

ERI (quarterly) = ERI (monthly)

0.14 4 𝑟
(1 + ) = (1 + )12
4 12

r = 13.84%
A man wished to have P40000 in a certain fund at the end of 8 years that
will pay a nominal rate of 6% compounded continuously. What is the
value of the compound amount factor for this rate?
SOLUTION:
F = Pern
ern = compound amount factor
e0.06(8) = 1.616
Compute the interest for an amount of P200, 000 for a period of 8 years if it was
made at 16% compounded continuously.

SOLUTION:

F = Pern
F = 200000e0.16(8)
F = P719,328

I=F–P
I = 719,328 – 200,000
I = P519,328
ANNUITIES – a series of equal payments occurring
at equal interval of time.
 TYPES OF ANNUITIES

ORDINARY ANNUITY – this type of annuity is one where the payments are
made at the end of each period beginning from the first period.
Present worth: Future worth:
0 1 2 3 4 n 0 1 2 3 4 n

A A A A A A A A A A

P F
A éë(1 + i)n - 1 ùû
P= A éë(1 + i)n - 1 ùû
( ) F=
n
1+i i i
Peter borrows P10, 000 from a bank on the first days of the month. The interest is
computed at the end of every month on the amount he still owed at the rate of
1.5% per month. Peter pays x pesos at the end of the first month, another x at the
end of the 2nd month and another x at the end of the 3rd month. Peter has
completely paid off the debt completely at the end of the 3rd month. Find the
value of x.

SOLUTION:

0 1 2 n=3 A éë(1 + i)n - 1ùû

P=
(1 + i)n i
x=A x=A x=A x éë(1.015)3 - 1ùû
10000 =
P=10,000 (1.015)3 (0.015)
x = P3434
A man receives P145,000 credit for his old car when buying a new model costing P375,000.
What cash payment will be necessary so that the balance can be liquidated by payments of
P12,500 at the end of each month for 18 months when interest is charged at the rate of 6%
compounded monthly?
SOLUTION:
Balance = 375,000 – 145,000
Balance = P230,000
Present worth of monthly payments of P12,500:
A éë(1 + i)n - 1ùû
P=
(1 + i)n i 0 1 2 3 4
0.06
i= = 0.005
12
12500 éë(1.005)18 - 1ùû A A A A A A A A
P=
(1.005)18 (0.005)
P
P = P214,660

Cash payment necessary

= 230000 – 214660
Cash payment necessary = P15,340
An employee is earning P18, 000 a month and he can only afford to purchase a car, which
will require a down payment of P85, 000 and a monthly amortization of 30% of his monthly
salary. What would be the maximum cash value of a car he can purchase if the seller will
agree to a down payment of P85, 000 and the balance payable in 4 years at 18 % per year
payable on monthly basis? The first payment will be due at the end of the first month.
SOLUTION:
A = 0.30(18000)
A = P5400 monthly amortization 4 yrs. = 4(12) = 48 months

A éë(1 + i)n - 1ùû 0 1 2 3 4 5

P=
(1 + i)n i
0.18
i= A A A A A A A A A A
12
i = 0.015 P
n = 4(12) = 48
5400 éë(1.015)48 - 1ùû
P=
(1.015)48 (0.015) Total cash value = 183830 + 85000
P = P183,830 (present worth of Total cash value = P268,830
the monthly payments)
ANNUITY DUE
- This type of annuity is one where the payments are made at the beginning of each period
beginning from the first period.
Present Worth of Annuity Due Future Worth of Annuity Due

A éë(1 + i)n - 1 - 1 ùû A éë(1 + i)n + 1 - 1 ùû

P= n -1
+A F= -A
(1 + i) i i
Difference Between the Sums of an Annuity Due and an Ordinary Annuity:
Difference = A[(1 + i )n - 1]
An engineering student bought a Lenovo laptop computer costing P 35,000 payable in 24
monthly payments, each installment payable at the beginning of each period. If the rate of
interest is 26% compounded monthly, compounded monthly, determine the amount of each
installment.

Solution:
P = 35,000
n = 24
i = r/m,
r = 26%
m = 12

𝐴[(1+𝑖)𝑛−1 −1]
P=
(1+𝑖)𝑛−1 𝑖
+A

26% 24−1
𝐴[(1+ ) −1]
12
35,000 = +A
26% 24−1 26%
1+ ( )
12 12

A = P1,845.62
P = 100,000
ERI (annual ) = 10 %
𝒎 𝒓 𝒎
ERI (monthly) = ( 1 + i ) - 1 = ( 1 + ) - 1
𝒎
m = 12
r = ?,
𝒓 𝟏𝟐
0.10 = ( 1 + ) -1
𝟏𝟐
r = 0.09569

n = 30 X 12 = 360 mos.

𝐴[(1+𝑖)𝑛−1 −1]
P=
(1+𝑖)𝑛−1 𝑖
+A

0.09569 360−1
𝐴[(1+ ) −1]
12
100,000 = 0.09569 360−1 0.09569
+A
1+ ( )
12 12

A = 839
DEFFERED ANNUITY
- This type of annuity is one where the first payment is deferred or is made several
periods after.
PRESENT WORTH, P:

Alternate Solution:

𝐴[1 − (1+𝑖)−𝑛′ ] 𝑨[ (𝟏+𝒊)𝒏′ −𝟏]

P= F=
𝑖(1+𝑖)𝑚′ Then,
𝒊

𝑭
P=
(𝟏+𝒊 )𝒏
FUTURE WORTH, F:

Alternate Solution:
𝐴[ (1+𝑖)𝑛′ −1]
F= 𝐴[1 − (1+𝑖)−𝑛′ ]
𝑖 P=
𝑖(1+𝑖)𝑚′
F = P(𝟏 + 𝒊 )𝒏
Mr. De la Rosa bought a piece of property for P 100,000 down payment and 10 semi-annual payments
Of P8,000 starting 3 years from now. If the interest rate is 12% compounded semi-annually, what is the
cash price of the property?
Solution

0.12 −10
𝐴[1 − (1+𝑖)−𝑛′ ] 8𝑘[1 − (1+ ) ]
2
P = DOWNPAYMENT + = 100,000 + = P 144, 000
𝑖(1+𝑖)𝑚′ 0.12 5 0.12
1+ ( )
2 2
SOLUTION:
SOLUTION:
Find the value after 20 years in pesos of an annuity of P20,000 payable
annually for 8 years, with the first payment at the end of 2 years, if money is
worth 5%.
8 11
SOLUTION:
0 1 2 3 4 5 6 7 8 9 10 1 1 18 19 20

AA A A A A A A

F1
F
A éë(1 + i) - 1ùû
n

F1 =
i
F = F1(1 + I )n
20000 éë(1.05)8 - 1ùû
F1 = F = 190982.18(1.05)11
(0.15)
F = P326, 644.33
F1 = P190,982.18
PERPETUITY
- This type of annuity is one where the payments are made an indefinite period of time
or perpetual ordinary annuity.

Present Worth:
𝑨
P=
𝒊
A = uniform payments
i = rate of interest for each period

Future Worth:
F = Infinite Sum
With interest rate of 9% compounded continuously, what is the present worth of a perpetuity
of P8000 payable monthly?

SOLUTION:
Solve for i:
Effective rate = (1 + i)12 – 1
Effective rate if compounded continuously = er – 1
(1 + i)12 – 1 = er – 1
(1 + i)12 – 1 = e0.09 – 1
(1 + i)12 = e0.09
1 + i = 1.007528
i = 0.007528

Present worth of perpetuity:

A 8000
P= = = P1,062,699.26
i 0.007528
QUIZ NO. 1- ENGINEERING ECONOMY
MW – 5.30 – 7.00 PM
Ordinary Annuity
1. Engr. Vincent Villas plans to deposit for the education of his
5 year old son, P500 at the end of each month for 10 years at
12% annual interest compounded monthly. The amount that
will be available in two years is
a. P 12,800 b. P 13,000 c. P 13,500 d. P 14,000
Annuity Due
3. Engr. Karlo Solatorio borrows P 100,000 at 10% interest
rate compounded monthly. He must pay back the loan
over 30 years with uniform monthly payments due on the
first day of each month. What does Engr. Solatorio pay
each month?

Deferred Annuity a. P 870 b. P 905 c. P 708 d. P 1001

2. Engr. John Pacres wishes to provide P 4,000 for his son on

his 21st birthday. How much should he deposit every 6 months
in a savings bank which pays 3% converted semi-annually, if
the first deposit is made when the son is 3 ½ year old?
a. P 63.22 b. P 68.35 c. P 79.10 d. P 84.50
CAPITAL RECOVERY

(FC - SV)(1 + i)n i

Capital recovery = + (S.V.)i
[(1 + i) - 1]
n
A machine which costs P50,000 when new has a 10-year lifetime and salvage
value equal to 10% of its original value. Determine the capital recovery, based
upon an interest rate of 8% per year compounded annually.

SOLUTION:

(FC - SV)(1 + i)n i

Capital recovery = + (S.V.)i
[(1 + i) - 1]
n

10
(50,000 - 5000)(1.08) (0.08)
= 10
+ 5000(0.08)
(1.08) - 1
Capital recovery = P7105
ARITHMETIC GRADIENT
Periodic payments that are made to increase or decrease by a fixed amount G (G is constant).
Equivalent Annual Amount
Problem

The maintenance on a machine is expected to be P 155

at the end of the first year and it is expected to increase
P 35 each year for the following 7 years. What sum of
money should be set aside now to pay the maintenance
for the eight year period? Assume 6% interest.
Problem

The maintenance of a room air conditioner is expected

to be P 2000 at the end of the first year and is expected
to increase by P 100 each year for the following 7 years.
Assuming a rate of interest is 6%, compute the
equivalent uniform annual cost.
Geometric Gradient
- Periodic payments that are made to increase or decrease by a fixed percentage, rg.
Sample Problem

Annual maintenance cost of a newly purchased motorcycle is

expected to be P 1,500 this year and estimated to increase 10% each
year every year. What is the present cost of the maintenance cost for
six years if (a) i = 8%, (b) i = 10% and (c) i = 12%.
Sample Problem

A young professional has decided to put up a construction business at age

40. He wishes to accumulate P 200,000 at that age. On his twenty-fifth
birthday he deposits a certain amount and will increase the deposit by
10% each year until the fortieth year. If the funds can be invested at 9.6%
compounded annually, how much should his initial investments be?
Sample Problem

A man makes a series of ten annual deposits starting at P 2,000 at the end
of the first year and increasing the amount deposited by 10% every year
thereafter. Find the total amount at the end of ten years if the rate of
interest on all sums on deposit is 8%.
Seat Work

Find the value of x in the arithmetic gradient CFD shown so that the two
cash flows will be equivalent if i = 12% per year.
Depreciation
The loss in value of a physical property due to passage of time.
Definitions

Value – the present worth of all future amounts that are expected to be received through
ownership of certain asset.

Market Value – the amount in which a willing buyer will pay to a willing seller to a property
where each has equal advantages.

Book Value – the worth of the property as recorded in the books of accounts of the
company and is equal to the original cost minus the amount which have been charged due
to depreciation.

Salvage Value – the amount that can be obtained by the sale of the property as second
hand.

Economic Life – the length of time the property maybe operated at a profit.
 Methods of Depreciation

1. Straight Line Method

- Assumes that the loss in value is directly proportional to the life of the property.

Problem

1. An equipment costing P 40,000 is to be delivered

at a cost of P 5,000 and installation cost of P 5, 000.
The equipment has a life of 5 years and
salvage value of P 4,000 at the end of its life. Compute the
depreciation until the 3rd year and book value after 3 years.

2. A contractor imported a concrete bagger mixer for his project,

paying P 250,000 to the manufacturer. Freight, Insurance, customs brokerage,
taxes and permits charges amounted to P 54,500. If the contractor estimates the
life of the mixer to be 10 years with a salvage value of P 20,000.
Determine the book value at the end of years.
2. Sinking Fund Method

- Usually established for replacement

- The equivalent amount of depreciation will be the equivalent amount
for the sinking fund at that time

Problem

1. An equipment costing P 40,000 is to be delivered

at a cost of P 5,000 and installation cost of P 5, 000.
The equipment has a life of 5 years and salvage value
of P 4,000 at the end of its life. Compute the
depreciation until the 3rd year and book value after 3 years.
Consider rate i = 12%.

2. A contractor imported a concrete bagger mixer for his project,

paying P 250,000 to the manufacturer. Freight, Insurance, customs brokerage,
taxes and permits charges amounted to P 54,500. If the contractor estimates the
life of the mixer to be 10 years with a salvage value of P 20,000.
Determine the book value at the end of 5 years. i = 12%.
3. Declining Balance Method

- Depreciation is assumed to be a fixed percentage of the salvage value at the

beginning of the year.
4. Double - Declining Balance Method (DDBM)

- Same with DBM but with different k formula.