Republic of the Philippines

CAVITE STATE UNIVERSITY-CCAT

Cavite College of Arts and Trades Campus
Rosario, Cavite
 (046)437-9505 /  (046)437-6659
[email protected]
www.cvsu-rosario.edu.ph

LEARNING MODULE

ENGINEERING ECONOMY
(ENSC 30)

Prepared by:

MICHAEL EDWARD T. ARMINTIA, REE, RME

Lecturer, Department of Engineering

First Semester
AY: 2020–2021
 CHAPTER 2: MONEY-TIME RELATIONSHIP AND EQUIVALENCE

I. OBJECTIVES
After the completion of this chapter, the students will be able to:
✓ identify additional terms used in engineering economics;
✓ solve word problems involving interest; and
✓ use a cash flow diagram in visualizing engineering economics problems.

II. INTRUCTIONS TO THE LEARNERS

This learning module must be utilized as follow:
✓ Keep and use it as neat as possible.
✓ For every chapter, pre-test will be given. This will be used to assess how much does a student
already know for that chapter. Answer key will be provided with this learning module. Answer key
must only be accessed right after finishing the pre-test.
✓ Lessons under each chapter will be discussed in “Learning Activities” section. Learning activities
include discussion, assignments, and exercises. Assignments and exercises will be done on this
learning module. Submission of assignments and exercises will be online for those who chose
online class and face-to-face for those who chose modular learning. NOTE: Submission of
requirements will be scheduled at least once a month to limit physical contact.
✓ Post-test will also be provided in each chapter. This will be used to assess if the students really
learned from different learning activities conducted. Answer key will also be provided and must
only be accessed after completing the post-test.
✓ This learning module is intended for electrical engineering students enrolled in Cavite State
University – CCAT Campus for academic year 2020-2021. Any form of reciprocation of this
learning module without the consent of the author is not allowed. Once caught, proper sanction
will be applied.
III. PRE-TEST

A. Determine what is being asked or described in each number. Choose the letter that corresponds
to your answer.

1. Refers to wealth in the form of money or property that can be used to produce more wealth.
a. capital b. interest
c. profit d. receipts

2. Defined as the interest on a loan or principal that is based only on the original amount of the
loan or principal.
a. compound interest b. simple interest
c. ordinary simple interest d. exact simple interest

3. Based on the banker’s year

a. compound interest b. simple interest
c. ordinary simple interest d. exact simple interest

4. Based on the exact numbers of days in a given year

a. compound interest b. simple interest
c. ordinary simple interest d. exact simple interest

5. Defined as the interest of loan or principal which is based not only on the original amount of
the loan or principal but the amount of loan or principal plus the previous accumulated interest.
a. compound interest b. simple interest
c. ordinary simple interest d. exact simple interest

6. Defined as the difference of future worth and present worth.

a. interest b. discount
c. profit d. receipt

7. Cost of borrowing money

a. interest b. rate of discount
c. rate of interest d. expenditure

8. Basic annual rate of interest

a. effective rate of interest b. simple rate of interest
c. exact rate of interest d. nominal rate of interest

9. Actual or exact rate of interest earned on the principal during a one-year period
a. effective rate of interest b. simple rate of interest
c. exact rate of interest d. nominal rate of interest

10. Used for visualization of the flow of money occurring at various time
a. inflows-outflows diagram b. cash flow diagram
c. time-value money diagram d. equivalence diagram
IV. PRE-TEST FEEDBACK

A. Determine what is being asked or described in each number. Choose the letter that corresponds
to your answer.

1. Refers to wealth in the form of money or property that can be used to produce more wealth.
a. capital b. interest
c. profit d. receipts

2. Defined as the interest on a loan or principal that is based only on the original amount of the
loan or principal.
a. compound interest b. simple interest
c. ordinary simple interest d. exact simple interest

3. Based on the banker’s year

a. compound interest b. simple interest
c. ordinary simple interest d. exact simple interest

4. Based on the exact numbers of days in a given year

a. compound interest b. simple interest
c. ordinary simple interest d. exact simple interest

5. Defined as the interest of loan or principal which is based not only on the original amount of
the loan or principal but the amount of loan or principal plus the previous accumulated interest.
a. compound interest b. simple interest
c. ordinary simple interest d. exact simple interest

6. Defined as the difference of future worth and present worth.

a. interest b. discount
c. profit d. receipt

7. Cost of borrowing money

a. interest b. rate of discount
c. rate of interest d. expenditure

8. Basic annual rate of interest

a. effective rate of interest b. simple rate of interest
c. exact rate of interest d. nominal rate of interest

9. Actual or exact rate of interest earned on the principal during a one-year period
a. effective rate of interest b. simple rate of interest
c. exact rate of interest d. nominal rate of interest

10. Used for visualization of the flow of money occurring at various time
a. inflows-outflows diagram b. cash flow diagram
c. time-value money diagram d. equivalence diagram
V. LEARNING ACTIVITIES

A. Discussion
B. Exercises
C. Assignment

A. DISCUSSION

1) Introduction
2) Interest
3) Simple Interest
4) Discount
5) Compound Interest
6) Continuous Compounding
7) Nominal and Effective Rate of Interest
8) Concept of Equivalence
9) Cash Flow

1) Introduction
• The term capital refers to wealth in the form of money or property that can be used to produce
more wealth. The majority of engineering economy studies involve commitment of capital for
extended periods of time, so the effect of time must be considered. In this regard, it is
recognized that a dollar today is worth more than a dollar one or more years from now because
of the interest (or profit) it can earn. Therefore, money has a time value.

2) Interest
• Interest has existed from earliest recorded human history. Records reveal its existence in
Babylon in 2000 B.C. In the earliest instances, interest was paid in money for the use of grain or
other commodities that were borrowed; it was also paid in the form of grain or other goods.
• Throughout early recorded history, typical annual rates of interest on loans of money were in the
neighborhood of 6% to 25%, although legally sanctioned rates as high as 40% were permitted in
some instances.
• The charging of exorbitant interest rates on loans was termed usury, and prohibition of usury is
found in the Bible. (See Exodus 22: 21–27.)
• During the Middle Ages, interest taking on loans of money was generally outlawed on scriptural
grounds. In 1536, the Protestant theory of usury was established by John Calvin, and it refuted
the notion that interest was unlawful. Consequently, interest taking again became viewed as an
essential and legal part of doing business.

3) Simple Interest
• Defined as the interest on a loan or principal that is based only on the original amount of the
loan or principal.
• When simple interest is applicable, the total interest, 𝐼, earned or paid may be computed using
the formula:

𝐼 = 𝑃𝑖𝑛
 Where:
𝑃= principal amount lent or borrowed;
𝑛 = number of interest periods (e.g., years);
𝑖= interest rate per interest period.

• The future amount (𝐹) of the principal may be calculated by adding the interest 𝐼 to the principal
amount 𝑃

𝐹 = 𝐼+𝑃
𝐹 = 𝑃 + 𝑃𝑖𝑛
𝐹 = 𝑃(1 + 𝑖𝑛)

Example 2.1:
₱1,000 was loaned at a simple interest rate of 10% per year. How much will be the interest after
three year?

𝐼 = 𝑃𝑖𝑛
𝐼 = (1,000)(0.1)(3)
𝐼 = 300

Therefore, the total amount owed at the end of three years will be the sum of principal amount
borrowed and the interest.

𝐹 =𝐼+𝑃
𝐹 = 300 + 1000 = 1,300

• There are two types of simple interest:

a. Ordinary Simple Interest
b. Exact Simple Interest

a. Ordinary Simple Interest

• Based on the banker’s year (composed of 12 months of 30 days which is equivalent to
360 days in a year)
• The value of 𝑛 that is used for ordinary simple interest is calculated as:

𝑑
𝑛=
360
Where:
𝑑 = number of days the principal was invested

b. Exact Simple Interest

• Based on the exact number of days in a given year (a normal year has 365 days while
a leap year has 366 days)
• The values of 𝑛 to be used for exact simple interest are:

𝑑
𝑛= for normal years
365
𝑑
𝑛= for leap years
366
 Example 2.2:
The exact simple interest of ₱5,000 invested from June 21, 1995 to December 25, 1995 is
₱100. What is the rate of interest?
First solve for 𝑛:
June = 30 − 21 = 9 days
July = 31 days
August = 31 days
September = 30 days
October = 31 days
November = 30 days
December = 25 days
TOTAL = 187 days

187
𝑛=
365

Then, solve for 𝑖:

𝐼 = 𝑃𝑖𝑛
𝐼
𝑖=
𝑃𝑛
100
𝑖=
187
5,000 ( )
365
𝑖 = 0.039𝑥100%
𝒊 = 𝟑. 𝟗𝟎%

4) Discount
• Difference of future worth and present worth

• Rate of discount (𝒅)

Discount in one unit of principal per unit time

𝐹−𝑃
𝑑=
𝑃
𝑑
𝑖= for rate of interest with discount
1−𝑑

Example 2.3:
A man borrowed ₱2,000 from a bank and promise to pay the amount for one year. He received
only the amount of ₱1,920 after the bank collected an advance interest ₱80. What is the rate of
discount and the rate of interest that the bank collected in advance?

𝐹−𝑃
𝑑=
𝑃
𝑃+𝐼−𝑃
𝑑=
𝑃
𝐼
𝑑=
𝑃
 80
𝑑=
2000
𝑑 = 0.04

𝑑
𝑖=
1−𝑑
0.04
𝑖=
1 − 0.04
𝑖 = 0.0417 x 100% = 4.17%

5) Compound Interest
• Defined as the interest of loan or principal which is based not only on the original amount of the
loan or principal but the amount of loan or principal plus the previous accumulated interest.
• Frequently used in commercial practice than simple interest, more specially if it is a longer
period which spans for more than a year.
• Future amount of the principal may be derived from the following tabulation:
Period Principal Interest Total Amount
1 𝑃 𝑃𝑖 𝑃 + 𝑃𝑖 = 𝑃(1 + 𝑖)

2 𝑃(1 + 𝑖) 𝑃(1 + 𝑖) ∙ 𝑖 𝑃(1 + 𝑖)(1 + 𝑖) = P(1 + i)2

3 𝑃(1 + 𝑖)2 𝑃(1 + 𝑖)2 ∙ 𝑖 𝑃(1 + 𝑖)2 (1 + 𝑖) = 𝑃(1 + 𝑖)3
𝑛 𝑃(1 + 𝑖)𝑛

• Future Worth
𝐹 = 𝑃(1 + 𝑖)𝑛
• Present Worth
𝐹
𝑃=
(1 + 𝑖)𝑛
Example 2.4:
A man loan from a bank worth ₱10,000. If the interest is 5% per annum, how much will he pay
at the end of 5 years?

𝐹 = 𝑃(1 + 𝑖)𝑛
𝐹 = 10,000(1 + 0.05)5
𝐹 = ₱12,762.82

6) Continuous Compounding
• The concept of continuous compounding is based on the assumption that cash payments occur
once per year but compounding is continuous throughout the year.
• The basic equation for future worth of compounded interest is:
𝐹 = 𝑃𝑒 𝑁𝑅𝑛
where:
𝑁𝑅 = nominal rate

Example 2.5:
A man invested ₱5,000 at an annual interest rate of 6% compounded continuously. What will be
its future worth after 4 years?
 𝐹 = 𝑃𝑒 𝑁𝑅𝑛
𝐹 = 5,000𝑒 (0.06)(4)
𝐹 = ₱6,356.25

7) Nominal and Effective Rate of Interest

• Rate of Interest
o Cost of borrowing money.
o Has two types: nominal and effective rate of interest
• Nominal Rate of Interest
o Basic annual rate of interest
• Effective Rate of Interest
o Actual or the exact rate of interest earned on the principal during a one-year period

• The following formulas are used to determine the effective rate of interest:
𝐸𝑅 = (1 + 𝑖)𝑚 − 1
𝑁𝑅 𝑚
𝐸𝑅 = (1 + ) −1
𝑚
where:
𝑚 = number of interest period per year
𝑁𝑅
𝑖 = interest per period ( )
𝑚
𝑁𝑅 = nominal rate of return
𝑖 = 𝑁𝑅 when compounding is annually

Example 2.6:
A principal amount is invested in 5% compounded quarterly.

In this statement, the nominal rate is 5% while the effective rate is greater than 5% because of
the compounding which occurs four times a year.

0.05 4
𝐸𝑅 = (1 + ) −1
4
𝐸𝑅 = 0.0509 x 100% = 5.09%

8) Concept of Equivalence
• Alternatives should be compared when they produce similar results, serve the same purpose, or
accomplish the same function.
• We should consider the comparison of alternative options, or proposals, by reducing them to an
equivalent basis that is dependent on:
o the interest rate
o the amounts of money involved
o the timing of the monetary receipts or expenses

Example 2.7:
A man has a $17,000 balance on his credit card. He decided to repay his $17,000 debt in four
months. An unpaid credit card balance at the beginning of a month will be charged interest at
the rate of 1% by his credit card company.
 Figure 2.1. Three alternatives or plans to be considered

Plan 1 indicates that none of the principal is repaid until the end of the fourth month. The
monthly payment of interest is $170, and all of the principal is also repaid at the end of month
four. Because interest does not accumulate in Plan 1, compounding of interest is not present
in this situation.

Plan 2 stipulates that we repay $4,357.10 per month. (How $4,357.10 was computed will be
discussed at later topic) Observe that interest is being compounded and that the $17,000
principal is completely repaid over the four months.

Plan 3 shows that the principal and accumulated interest will be paid at the end of the fourth
month.

If the interest rate remains at 1% per month, you should be indifferent as to which plan you
use to repay the $17,000 to your credit card company. Considering the total accumulated
interest, plan 2 or second alternative will be the best option among three.

9) Cash Flow
• The use of cash-flow (time) diagrams or tables is strongly recommended for situations in which
the analyst needs to clarify or visualize what is involved when flows of money occur at various
times.
• The difference between total cash inflows (receipts) and cash outflows (expenditures) for a
specified period of time (e.g., one year) is the net cash flow for the period.
• The usefulness of a cash-flow diagram for economic analysis problems is analogous to that of
the free-body diagram for mechanics problems.
• The cash flow diagram employs several conventions:
1. The horizontal line is a time scale, with progression of time moving from left to right. The
period (e.g., year, quarter, month) labels can be applied to intervals of time rather than to
points on the time scale.
2. The arrows signify cash flows and are placed at the end of the period. If a distinction
needs to be made, downward arrows represent expenses (negative cash flows or cash
outflows) and upward arrows represent receipts (positive cash flows or cash inflows).
3. The cash-flow diagram is dependent on the point of view. For example, the situations
shown in succeeding cash flow diagrams were based on cash flow as seen by the lender
(the credit card company). If the directions of all arrows had been reversed, the problem
would have been diagrammed from the borrower’s viewpoint.

Figure 2.2. Cash flow diagram of example 2.7 plan 3 using the viewpoint of credit card company

Figure 2.3. Cash flow diagram of example 2.7 plan 2 using the viewpoint of credit card company
B. EXERCISES

Exercise Number 1
Objective(s) Identify additional terms used in engineering economics.
Instruction Identify what is being asked in each number. Encircle the letter that
corresponds to your answer.

1. Difference of total cash inflows and total cash outflows

a. net cash flow b. profit
c. interest d. revenue

2. Cost of borrowing money

a. principal interest b. rate of interest
c. compound interest d. simple interest

3. Defined as the interest of loan or principal which is based not only on the original amount of the
loan or principal but the amount of loan or principal plus the previous accumulated interest.
a. principal interest b. rate of interest
c. compound interest d. simple interest

4. Defined as the interest on a loan or principal that is based only on the original amount of the
loan or principal.
a. principal interest b. rate of interest
c. compound interest d. simple interest

5. The charging of exorbitant interest rates on loans.

a. tax b. plunder
c. usury d. Pillage

6. Basic annual rate of interest

a. effective rate of interest b. nominal rate of interest
c. rate of discount d. discounted interest

7. Actual or exact rate of interest earned on the principal during a one-year period.
a. effective rate of interest b. nominal rate of interest
c. rate of discount d. discounted interest

8. Strongly recommended for situations in which the analyst needs to clarify or visualize what is
involved when flows of money occurs at various times.
a. free body diagram b. cash-flow diagram
c. price-demand relationship d. book of account

9. Simple interest that is based on the banker’s year.

a. calendar simple interest b. banker’s simple interest
c. ordinary simple interest d. exact simple interest

10. Simple interest that is based on the exact number of days in a given year.
a. calendar simple interest b. banker’s simple interest
c. ordinary simple interest d. exact simple interest
Exercise Number 2
Objective(s) Solve word problems involving interest.
Instruction Solve the following word problems regarding interest. Show your solution on
the space provided.

1. If P1,000 accumulates to P5,000 when invested at a simple interest for three years, what is the
rate of interest?

2. It is the practice of almost all banks in the Philippines that when they grant a loan, the interest
for one year is automatically deducted from the principal amount upon release of money to a
borrower. Let us therefore assume that you applied for a loan with a bank and the P80,000
was approved with an interest of 14% of which P11,200 was deducted and you were given a
check of P68, 800. Since you have to pay the amount of P80,000 one year after, what then will
be the effective interest rate?

3. P5,000 is borrowed for 75 days at 16% per annum simple interest. How much will be due at
the end of 75 days?

4. An amount of P1,000 becomes P1,608.44 after 4 years compounded bimonthly. Find the
nominal interest. (Note: bimonthly means 6 times a year)

5. What nominal rate compounded semi-annually, yields the same amount as 16% interest
compounded quarterly?
C. ASSIGNMENT

Objective(s) Use a cash flow diagram in visualizing engineering economics problems

Instruction Illustrate the cash inflows and cash outflows in the situation by using a cash
flow diagram.

A man has a $17,000 balance on his credit card. He decided to repay his $17,000 debt in four
months. An unpaid credit card balance at the beginning of a month will be charged interest at the
rate of 1% by his credit card company. One alternative the man can choose is to pay interest due at
the end of each month and principal at the end of fourth month as shown in the table below.
Construct two cash flow diagrams for this situation (one using the view point of the credit card
company and another cash flow diagram using the viewpoint of the man with the balance on his
credit card).

Month Amount Owed at Interest Total Money Principal Total End of

the Beginning of Accrued for Owed at the End Payment the Month
the Month Month of the Month Payment
1 $17,000 $170 $17,170 0 $170
2 $17,000 $170 $17,170 0 $170
3 $17,000 $170 $17,170 0 $170
4 $17,000 $170 $17,170 $17,000 $17,170

Cash Flow Diagram (Credit Card Company Viewpoint)

Cash Flow Diagram (Credit Card User Viewpoint)

VI. POST-TEST

A. Solve the following word problems. Show your solution on the space provided.

1. If P10,000 accumulates to P1,500 when invested at a simple interest for three years, what is the
rate of interest?

2. If you borrowed P10,000 from a bank with 18% interest per annum, what is the total amount to
be repaid at the end of one year?

3. Annie buys a television set from a merchant who ask P1,250 at the end of 60 days. Annie
wishes to pay immediately and the merchant offers to compute the cash price on the assumption
that money is worth 8% simple interest. What is the cash price?

4. What is the effective rate corresponding to 18% compounded daily? Take 1 year is equal to 360
days.

5. Compute the equivalent rate of 6% compounded semi-annually to a rate compounded quarterly

VII. POST-TEST FEEDBACK

A. Solve the following word problems. Show your solution on the space provided.

1. If P10,000 accumulates to P1,500 when invested at a simple interest for three years, what is the
rate of interest?
𝐹 = 𝑃(1 + 𝑖𝑛)
1,500 = 1,000(1 + 𝑖(3))
1,500
3𝑖 = −1
1000
𝑖 = 16.67%

2. If you borrowed P10,000 from a bank with 18% interest per annum, what is the total amount to
be repaid at the end of one year?
𝐹 = 𝑃(1 + 𝑖𝑛)
𝐹 = 10,000(1 + 0.18(1))
𝐹 = 11,800

3. Annie buys a television set from a merchant who ask P1,250 at the end of 60 days. Annie
wishes to pay immediately and the merchant offers to compute the cash price on the assumption
that money is worth 8% simple interest. What is the cash price?

𝐹 = 𝑃(1 + 𝑖𝑛)
60
1,250 = 𝑃 (1 + 0.08 ( ))
360
𝑃 = 1,233.55

4. What is the effective rate corresponding to 18% compounded daily? Take 1 year is equal to 360
days.

𝐸𝑅 = (1 + 𝑖)𝑚 − 1
0.18 360
𝐸𝑅 = (1 + ) −1
360
𝐸𝑅 = 19.72%

5. Compute the equivalent rate of 6% compounded semi-annually to a rate compounded quarterly

𝐸𝑅𝑠𝑒𝑚𝑖−𝑎𝑛𝑛𝑢𝑎𝑙𝑙𝑦 = 𝐸𝑅𝑞𝑢𝑎𝑟𝑡𝑒𝑟𝑙𝑦
0.06 2 𝑁𝑅 4
(1 + ) = (1 + )
2 4
𝑁𝑅 = 5.96%