Engineering Economics

INSTRUCTIONS: Solve the problems independently. When applicable, provide explanations to

justify conclusions as thoroughly as possible and/or show complete solutions while highlighting
the final answers. Answers with neither supporting explanations nor solutions will not be given
credit.

1. Your company is considering the introduction of a new product line. The initial investment
required for this project is ₱30,000,000, and annual maintenance costs are anticipated to be
₱2,500,000. Annual operating costs will be directly proportional to the level of production at
₱460 per unit, and each unit of product can be sold for ₱3,300. If the MARR is 16.5% and
the project has a life of 7 years, what is the minimum annual production level for which the
project is economically viable?

- For economic viability of this project, we need to check the production level at which
present value of future cash flow = initial cost i.e. NPV of this project will be zero, that will
be the minimum viable level of production.
Given:
A = ₱30,000,000
P =₱2,500,000
V = ₱460/unit
Z = ₱3,300
X =minimum viable level of production
Y = annual profit
MARR = 16.5%
n = 7 yrs.

Solution:
Y = 3,300X – 460X – 2,500,00
Y = 2840X – 2,500,000

( PVIFA ,i , n )=1−¿ ¿

( PVIFA ,16.5 % ,7 yrs . )=1−¿ ¿

(PVIFA, 16.5%, 7yrs.) = 3.98

Solving for Y:
NPV = -30,000,000+ Y(3.98)
30,000,000 Y (3.98)
=
3.98 3.98
Y = 7537688.442

Solving for X:
Y = 2840x – 2,500,000
7537688.442 = 2840X – 2,500,000

7537688.442+2,500,000 X 2840
=
2840 2840
X = 3534.397 -> 3535 units
 Therefore, minimum annual production level for which the project is economically
viable is 3535 units.

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2. A company sold a ₱75,000,000 issue of bonds with a 19-year life, paying 5% interest per
year. The bonds were sold at par value. If the company paid a selling fee of ₱3,000,000 and
has an annual expense of ₱4,512,800 for mailing and record keeping, what is the true rate of
interest that the company is paying for the borrowed money?

Given:
P = ₱75,000,000
n = 19yrs.
i = 5%
S = ₱3,000,000
Z = ₱4,512,800

Solution:
Total coupon payment = 5%(75,000,000)( 19)
= ₱71, 250,000
Total rate of interest = 71, 250,000/75,000,000 (100)
= 0.95(100)
Total rate of interest = 95%
 Therefore, the true rate of interest that the company is paying for the borrowed money
is 95%.

3. In August of 2018, Taylor purchased 2,500 shares of XYZ common stock for ₱3,800,000. He
then sold 1,500 shares of XYZ in August of 2019 for ₱1,999 per share. The remaining 1,000
shares were finally sold for ₱2,599 per share in August 2020.
a. Draw a cash-flow diagram of this situation.
b. What was Taylor’s internal rate of return (IRR) on this investment?
c. What was the ERR on this investment if the external reinvestment rate is 7.5% per
year?

Given:
P = ₱3,800,000->2,500 shares
A = ₱1,999/share
SA = 1,500
B = ₱2,599/share
SB = 1,000
i = 7.5%

a. Cash-flow Diagram

b. Internal Rate of Return (IRR)

1,999(1,500)
3,800,000= ¿¿
2,998,500
3,800,000=
¿¿

IRR1 = -1.52

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 IRR2 = 0.31 (100) = 31%
 Therefore, Taylor’s Internal Rate of Return (IRR) on this investment 31%.

c. External Rate of Return (ERR)

2,998,500+2,599,000
ROI=( ×100)-100
3,800,000
= 47.30%/2
= 23.65%
i = 7.5%
ERR = 23.65% - 7.5%
ERR = 16.15%
 Therefore, the External Rate of Return (ERR) on this investment if the external
reinvestment rate is 7.5% per year is 16.15%.

Prepared by:

Zaeefa Pandangan
Instructor

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