Engineering  

Economy
Interest
Interest is the amount of money earned by a
given capital. From the barrower’s viewpoint,
interest is the amount of money paid for the
use of a borrowed capital. From the lender’s
viewpoint, it is the income generated by the
capital that was lent.
Cash  Flow  Diagrams
Cash flow diagrams may be drawn to help
visualize and simplify problems having diverse
receipts and disbursements.
Simple  Interest

In a simple interest, the interest earned by

the principal is computed at the end of the
investment period, and thus, it varies directly
with time.
Ordinary  and  Exact  Simple  Interest
In ordinary simple interest, the interest is
computed on the basis of one banker’s year.

1  banker’s  year  =  12  months

(30  days  each  month)  =  360  days
Ordinary  and  Exact  Simple  Interest

In exact simple interest, the interest is based

on the exact number of days of the year,
where there are 365 days for an ordinary year
and 366 days for the leap years.
Ordinary  and  Exact  Simple  Interest

Leap years occurs every four years for years

that is exactly divisible by four, except century
marks (1800, 1900, etc.) but not including
those that are divisible by 400 (2000, 2400,
etc.)
Elements  of  Simple  Interest
P  =  principal  or  present  worth
I  =  interest  earned
F =  future  worth
F  =  P  +  I
r  =  simple  interest  rate  (per  year)
t  =  time  in  years  or  fraction  of  a  year
Elements  of  Simple  Interest
Note:
P may stand for the amount borrowed or
invested, while F may stand for the amount to
be paid or amount accumulated
I  =  Prt
F  =  P  +  I  =  P  +  PRT
F  =  P(1  +  rt)
Value  of  “t”:
Example:
• 4  years
• 3  months
• 90  days
• 2  years  &  4  months
Example  1
An ordinary simple interest rate of 8.5% per
year is applied on a P50,000.00 loan made on July
01, 2005. Find the lump sum interest to be paid on
the loan on June 05, 2012.
Example  2
Using the same data in Example 1, determine
the total amount to be paid on the loan if an exact
interest rate of 7.5% is used.
Compound  Interest
In compound interest, the interest is computed
every end of each interest period (compounding
period), and the interest earned for that period is
added to the principal (interest plus principal).
To demonstrate this, consider and investment
of P1000 to earn 10% per year for three years. The
following diagram shows how the money grows.
Compound  Interest
Elements  of  Compound  Interest
P =  present  worth  or  principal
F =  future  worth  or  principal
𝑖 =  effective  interest  per  compounding  period  
(per  interest  period)
𝑖 = 𝑟/𝑚
𝑛 =  total  number  of  compoundings
𝑛 = 𝑡  𝑥  𝑚
Elements  of  Compound  Interest
𝐼 =  interest  earned
𝐼 =𝐹−𝑃
𝑟 =  nominal  interest  rate
𝐸𝑅 =  effective  interest
𝑡 =  number  of  years  of  investment
𝑚 =  number  of  compoundings per  year
Future  Worth  “F”
The  present  worth  F  is:
F
P=
(1+ i ) n

0
The term (023)5
, also denoted(P/F, I, n) is
called the single payment present-­‐worth factor.
Present  Worth  “P”
After  n  periods,  the  compound  amount  F is:

F = P (1+ i )
n

The term  (1 + 𝑖)8 , also denoted as (F/P, i, n)

is called the single payment compound-­‐amount
factor.
Values  of  “i”  and  “n”
The following examples show how to get
the values of i and n.

Nominal interest rate, r = 12%

Number of years of investment,
t = 5 years
Example
a.  Compounded  annually (m  =  1)
b.  Compounded  semi-­‐annually (m  =  2)
c.  Compounded  quarterly (m  = 4)
d.  Compounded  monthly (m =  12)
e.  Compounded  bi-­‐monthly (m =  6)
Continuous  Compounding  (m  →  ∞)
Interest may be compounded daily, hourly,
per minute, etc. As a limit, interest may be
considered to be compounded an infinite
number of times per year (m →  ∞).
The future worth of P at an interest rate of r
compounded continuously for t years is:

F = Pe n
Effective  Interest  Rates
Thus  the  effective  rate  of  interest  (ER) is  the  
actual  interest  earned  in  one  year  period.  This  
can  be  computed  by  either  of  the  following:
m
⎛ r⎞
ER = ⎜ 1+ ⎟ − 1
⎝ m⎠

ER = e − 1
r
Example  3

A bank offers 0.5% effective monthly interest.

What is the equivalent effective annual rate?
Example  4
A house and lot costing P2M was bought at a
down payment of P500,000.00 and P1M after one
year. The remaining balance will be paid at the
end of the third year. If the interest rate is 24%
compounded semi-­‐annually, what is the required
payment?
Example  5
East Side Bank offers the following effective
rates on 5-­‐year loans; 8% for the first two years,
10% for the third year, 11% for the fourth year,
and 12% on the fifth year. If P500,000.00 is
borrowed, determine the lump-­‐sum amount to be
paid at the end of the loan period.
Annuity

Annuity  is  a  series  of  uniform  payments  

mate  at  equal  intervals  of  time.
Annuities  are  established  for  the  following  
purposes:
Annuity
• As the payment of a debt by a series of equal
payment at equal time intervals, also known as
amortization.
• To accumulate a certain amount if the future by
depositing equal amounts at equal time intervals.
These amounts are called sinking fund
• Asa substitute periodic payment for a future
lump sum payment
Elements  of  Annuity
A  =  periodic  payment
P  =  present  worth  of  all  periodic  payments
F  or  S  =  future  worth  or  sum  of  all  the  periodic  
payments  after  the  last  payment  is  made
i =  interest  rate  per  payment
n  =  number  of  payments
TYPES  OF  ANNUITY

• Ordinary  Annuity
In ordinary annuity, the payment is made
at the end of each period starting from the first
period, as in the diagram shown below.
Future  worth  “A”
The  future  worth  A  is:
A ⎡⎣(1+ i ) − 1⎤⎦
n

F=
i
Future  worth  “A”
023 :05
The  factor   is  called  equal-­‐payment-­‐
3
series  composed-­‐amount  factor and  is  denoted  
as  (F/A,  i ,  n)
Values  of  “A” with  known  F (sinking-­‐fund)
The values of A if F is known is

Fi
A=
(1+ i ) − 1
n
Present  worth  of  “A”
The  present  worth  of  A  is:

A ⎣(1+ i ) − 1⎤⎦
⎡ n
F
P= =
(1+ i ) n
(1+ i ) i
n
Present  worth  of  “A”
(023)5:0
The factor (023)53
, is known as equal-­‐
payment series present-­‐worth factor and is
designated as (P/A, i, n)
Value  of  A  with  known  P  (capital  recovery)

The  value  of  A with  known  P is:

P (1+ i ) i
n

A=
(1+ i ) n
−1
Value  of  A  with  known  P  (capital  recovery)

(023)53
The factor , is known as the equal
(023)5:0
payment-­‐series-­‐capital-­‐recovery factor and is
designated as (A.P, i, n)
Example  6
The president of a growing engineering firm
wishes to give each of 50 employees a holiday
bonus. How much is needed to invest monthly for
a year at 12% nominal interest rate, compounded
monthly, so that each employee will receive
P1,000.00 bonus?
TYPES  OF  ANNUITY
• Deferred  Annuity
In this type, the first payment is deferred a
certain number of periods after the first.
Consider cash flow diagram below.
TYPES  OF  ANNUITY
• Deferred  Annuity
For  the  cash  flow  diagram  shown  above,  the  
following  calculations  can  be  made  for  solving  P and  
F.
To  solve  for  the  future  worth  F:

A ⎣(1+ i ) − 1⎤⎦
⎡ 4

F=
i
TYPES  OF  ANNUITY

• Deferred  Annuity
To  solve  for  the  present  worth  P:

A ⎡⎣(1+ i ) − 1⎤⎦
4
F
P= =
(1+ i ) 5
(1+ i ) i
5
Example  7
A parent on the day that child is born wishes to
determine what lump sum would have to be paid
into an account bearing interest at 5%
compounded annually, in order to withdraw
P20,000.00 each on the child’s 18th, 19th, 20th, and
21st birthdays?
TYPES  OF  ANNUITY
• Annuity  Due
If  the  payment  is  made  at  the  beginning  of  each  
period  starting  from  the  first  period,  the  annuity  is  
called  annuity  due.

A ⎣(1+ i ) − 1⎤⎦
⎡ n

P=
(1+ i ) i
n
Example  8
An engineer wishes to take out a P150,000.00
educational policy for his son, If money is worth
14% effective, find the premiums to be paid
a. If five yearly payments are needed
b. If 20 quarterly payments are required
TYPES  OF  ANNUITY
• Continuous  Compounding
⎡ e − 1⎤
in
F = A⎢ i ⎥
⎣ e −1 ⎦
Example  9

To accumulate P150,000.00, uniform deposits

every six months will be required for the next 12
years. Determine the amount of each deposit if
the applied nominal rate is 9% compounded
continuously.
PERPETUITY
Perpetuity is an annuity where the payment
periods extend forever or the periodic payments
continue indefinitely.
If the payment is made at the end of each period
starting from the first period, the present worth of
perpetuity is:
A
P=
i
UNIFORM  GRADIENT
üArithmetic Gradient

Present Worth:
A ⎣(1+ i ) − 1⎤⎦ G ⎡ (1+ i )n − 1
⎡ n
n ⎤
P= + ⎢ n − n ⎥
(1+ i ) i
n
i ⎣ i (1+ i ) (1+ i ) ⎦
UNIFORM  GRADIENT
üArithmetic Gradient

Future Worth:
A ⎣(1+ i ) − 1⎤⎦ G ⎡ (1+ i )n − 1 ⎤
⎡ n

F = P (1+ i )
n
= + ⎢ − n⎥
i i ⎣ i ⎦
UNIFORM  GRADIENT
üGeometric Gradient
Example  10
An individual makes five deposits that increase
uniformly by P300.00 every month in a savings
account that earns 12% interest compounded
monthly. If the initial deposit is P4,500.00,
determine the accumulated amount in the acount
just after the last deposit.
 A ⎡⎣(1+ i ) − 1⎤⎦ G ⎡ (1+ i )n − 1 ⎤
n

F = P (1+ i )
n
= + ⎢ − n⎥
i i ⎣ i ⎦
CAPITALIZED COST AND ANNUAL COST
Capitalize Cost, K

Capitalized cost is an application of perpetuity.

The capitalized cost of a project or structure is the
sum of the first cost (FC) and the present worth of all
future payments and replacements which is
assumed to continue forever.
CAPITALIZED COST AND ANNUAL COST
Capitalize Cost, K
If a project requires a first cost of FC, annual
operation and maintenance of OM for 𝑛 years, a
salvage value of SV after every 𝑛 years, and a
replacement cost of RC after every end of 𝑛 years,
then the capitalized cost is:
CAPITALIZED COST AND ANNUAL COST
Capitalize Cost, K

Capitalized  cost,  K
OM RC − SV
K = FC + +
i (1+ i ) − 1
n
CAPITALIZED COST AND ANNUAL COST
Capitalize Cost, K

If RC is not applied, use RC = FC.

Capitalized cost may also be defined as the first
cost plus the present worth of annual maintenance
and operation cost plus the present worth of
depreciation assumed to continue forever.
Annual  Cost,  AC
The  annual  cost  (AC) of  a  project  is:
AC = Annual interest on investment + Annual
operation and maintenance and maintenance +
Annual depreciation cost
In  relation  to  capitalized  cost,  AC is:
Annual  cost:
AC = Ki
Annual  Cost,  AC

AC = ( FC ) i + OM +
( RC − SV ) i
(1+ i ) − 1
n
Example  11:
A machine cost P300,000.00 new, and must
be replaced at the end of each 15 years. If the
annual maintenance required is P5,000.00, find
the capitalized cost, if money is worth 5% and
the final salvage value is P50,000.
COST COMPARISON OF DIFFERENT
ALTERNATIVES
If two or more different articles are available for
the same purpose, they are equally economical if the
corresponding present worth, annual cost or
capitalized costs are the same.
Example  12
A certain equipment costs P150,000.00, lasts
for 6 years, and has a salvage value of P30,000.
How much could an investor afford to pay for
another machine for the same purpose, whose
life is 10 years and salvage value if P40,000, if
money is worth 5%?
DEPRECIATION
Depreciation refers to the decrease in the value of
an asset, due to usage of passage of time. An asset
may depreciate physically or functionally.
DEPRECIATION
Elements  of  Depreciation
• 𝐹𝐶 =  first  cost
• 𝑆𝑉 = salvage  value  or  trade-­‐in  value
• 𝑑 =  depreciation  charge
• 𝑛 =  economic  life  of  the  property  in  years
• 𝑚 =  any  time  before  𝑛
• 𝐵𝑉@ =  book  value  after  𝑚 years
• 𝐷@ =  total  depreciation  for  𝑚 years
DEPRECIATION
The following diagram shows the cost of the
property plotted versus time.
DEPRECIATION

• Book  Value
The  book  value  of  the  property  at  any  time  𝑚 is:

BVm = FC − Dm
METHODS  OF  COMPUTING  DEPRECIATION

• Straight  Line  Depreciation(SLD)

This is the most common method used in
computing depreciation. In this method, the cost of
the property is assumed to very linearly with time.
The following formulas are used.

FC − SV
d=
n
METHODS  OF  COMPUTING  DEPRECIATION

• Straight  Line  Depreciation(SLD)

In some cases, the life 𝑛 may be the number of
outputs. An example of this is the copying machine
(XEROX) where the life span is independent on the
number of copies made.
Example  13:
An engineer bought an equipment for
P500,000.00. Other expenses including
installation amounted to P30,000.00. At the
end of its estimated useful life of 10 years, the
salvage value will be 10% of the first cost.
Using straight line method of depreciation,
what is the book value after five years?
METHODS  OF  COMPUTING  DEPRECIATION

• Sinking  Fund  Method

In this method, an imaginary fund 𝑑 called a
sinking fund is invested yearly at a rate of 𝑖 to
amount to (FC-­‐SV) at the end of the life of the
property. ( FC − SV ) i
d=
(1+ i )n − 1
d ⎡⎣(1+ i ) − 1⎤⎦
m

Dm =
i
Example  14:

A pick – up truck costs P960,000.00 and is

expected to be used for 10 years after which it
will have a salvage value of P160,000.00. Find
the book value at the end of the third year
using 8% sinking fund method.
 METHODS  OF  COMPUTING  DEPRECIATION
• Sum  of  the  Years  Digit  Method(SOYD)
The depreciation charge in this method is
assumed to vary directly to the number of years and
inversely to the sum of the year’s digit.
n
Sum.of .year ' s.digit(SUM ) = (1+ n )
2
n − m +1 m ( 2n − m + 1)
dm = ( FC − SV ) Dm = ( FC − SV )
SUM 2 ( SUM )
Example  15:

ABC construction bought an equipment for

P60,000.00 with a salvage value of P10,000.00.
The equipment is expected to have a life of 10
years. Find its book value after 6 years.
METHODS  OF  COMPUTING  DEPRECIATION

• Declining  Balance  Method  (Constant  percentage  

method/Matheson  Method)
The method is based on the compound interest
formula 𝐹 = 𝑃(1 + 𝑖)8 , where 𝑃 is the first cost, FC,
F is the book value at any time, and 𝑖 is the
depreciation rate and is equal to –K. Then:
METHODS  OF  COMPUTING  DEPRECIATION
• Declining  Balance  Method  (Constant  percentage  
method)
BVm = FC (1− K )
m

SV = FC (1− K )
n

Constant  percentage  (K)

SV
dm = FC (1− K )
m−1
K = 1− n K
FC
Example  16:

A power plant purchases a fire tube boiler for

P525,000.00. It is estimated to have a scrap
value of P30,000.00 after 12 years. Using the
Matheson formula, find
a. The depreciation charge for the fourth year
b. The book value at the end of seven years.
METHODS  OF  COMPUTING  DEPRECIATION
• Double  Declining  Balance  Method
B
Depreciation charge to date= 𝑥  𝐵𝑉 at the
8
beginning of the year.
m
⎛ 2⎞
BVm = FC ⎜ 1− ⎟ ≥ SV
⎝ n⎠
2
dm = BVm
n
Example  17:

Ice bottling company purchased a filling

machine for P1M with additional cost for
optional features amounting to P120,000.00.
For an expected life of five years, determine
the accumulated depreciation after three years
using the Double Declining Balance Method.
CAPITAL  RECOVERY  (DEPLETION)
• If you invest FC now and desires a rate of return of
𝑟 and 𝑛 periods, and if you can deposit to an
account earning an interest or 𝑖 and 𝑛 periods to
recover an amount of RC, and you will also receive
a salvage value of SV from your invested property
at the end of 𝑛 periods, then the periodic dividend
or income D required is:
CAPITAL  RECOVERY  (DEPLETION)

D = ( FC ) r +
( RC − SV ) i
(1+ i ) − 1
n

Note:  If  RC is  not  specified,

𝑅𝐶 = 𝐹𝐶.
Example  18:
A mine costs P21M, and will last for 20years. Its
plant has a salvage value of P1M, at the end of the
time. The mine will yield an equal dividend at the
end of each year. What is the annual dividend, if it is
sufficient to pay interest annually at the rate of 6%
on the original investment and to accumulate a
replacement fund, invested at 4%?
BONDS

A bond is a written contract to pay a certain

redemption value C on a specified redemption date
and to pay equal dividends D periodically.
BONDS
Elements  of  Bond
• 𝐹=  face  value  or  par  value  of  the  bond
• 𝐶=  redemption  value  on  a  specified  
redemption  date
• r =  bond  rate  or  divided  rate
• D =  periodic  dividend
• 𝐷 = 𝐹  𝑥  𝑟
• 𝑖 =  investor’s  interest  rate  of  return
BONDS
Elements  of  Bond
• 𝐹=  face  value  or  par  value  of  the  bond
• 𝐶=  redemption  value  on  a  specified  redemption  
date
• r =  bond  rate  or  divided  rate
• D =  periodic  dividend
• 𝐷 = 𝐹  𝑥  𝑟
• 𝑖 =  investor’s  interest  rate  of  return
• 𝑃 =  price  of  the  bond  at  a  given  interest  𝑖
BONDS
• A  bond  is  said  to  be  redeemable  at  par  if  the  
redemption  value  C  equals  the  face  value  of  F.
• A  bond  is  said  to  be  redeemable  at  a  premium  if  C>F.
• A  bond  is  said  to  be  redeemable  at  a  discount  if  C<F.
BONDS
• Price  of  a  bond  at  a  given  “I”
D ⎣(1+ i ) − 1⎤⎦
⎡ n
C
P= +
(1+ i ) n
(1+ i ) i
n
Example  19

A P100,000.00, 6% bond, pays dividends

semiannually and will be redeemed at 110% on July
1, 1999. Find its price if bough on July 1, 1996, to
yield on investor 4%, compounded semi-­‐annually.
BREAKEVEN  ANALYSIS
Break-­‐even analysis is method of determining
when costs exactly equal revenue. If the
manufactured quantity is less than the break-­‐even
quantity, a loss is incurred. If the manufactured
quantity is greater than the break-­‐even quantity, a
profit is incurred.
BREAKEVEN  ANALYSIS
• 𝑓 =  fixed  cost  which  does  not  vary  with  production
• 𝑎  =  an  incremental  cost  which  is  the  cost  to  produce  
one  additional  item.  It  may  also  be  called  the  marginal  
cost  or  differential  cost.
• 𝑁 =  break-­‐even  point  or  quantity  produced  and  sold  for  
break-­‐even
• 𝑝 =  incremental  revenue  or  selling  price  per  unit
• 𝑅 =  total  revenue
• 𝑅 =  𝜌𝑁
BREAKEVEN  ANALYSIS
C  =  total  cost
C = f + aN
Assuming  there  is  no  change  in  inventory,  the  
break-­‐even  point  can  be  found  from:
Cost,  𝐶 =  Revenue,  𝑅

f + aN = pN
BREAKEVEN  ANALYSIS
Example  20
The cost of producing a computer diskette is as
follows: Material cost is P7.00 each, labor cost is
P2.00 each, and other expense is P1.50 each. If the
fixed expenses is P69,000.00 per month, how many
diskettes must be produced each month for break-­‐
even if each diskettes is worth P45.00?