MODULE 4 |. Lesson Title: ANNUITY, CAPITALIZED COST AND GRADIENT I. Overview: An annuity is defined by merriam-webster.com as “a sum of money payable yearly or at other regular intervals”. Wikipedia defines an annuity as “any recurring periodic series of payment’. ‘Some examples of annuities are regular payments into a savings account, monthly mortgage payments, regular insurance payments, etc. Annuities can be classified by when the payments are made. Annuities whose payments are made at the end of the period are called ordinary annuities. Annuities whose payments are made at the beginning of the period are called annuity-due. Annuities whose payments are deferred a certain number of periods are called deferred annuities. Annuities where the payments periods extend forever or called perpetuity. One of the most important applications of perpetuity is in capitalized cost. ‘The capitalized cost of any property is the sum of the first cost and the present worth of all costs of replacement, operation and maintenance for a long time or forever. In certain cases, Engineering Economy problems involve a series of disbursements or receipts that increase or decrease in such succeeding period by varying amounts. If the change in succeeding periods is constant, then the series is known as a uniform arithmetic gradient. If the change in succeeding periods is by a fixed percentage it is called geometric gradient. lll. Specific Objectives: At the end of this lesson, the students can 1. calculate the present value, future value, and equal payment of an ordinary annuity; 2. solve the present value, future value, and equal payment of a deferred annuity; 3. determine the present value, future value, and equal payment of an annuity due; 4. use perpetuity and other types of annuity formula in calculating capitalized cost; and 5. apply arithmetic gradient equations in computing the present value, future value, and equal payment of a gradient . IV. Materials Needed: Handouts, blackboard, chalks, books, LCD/LED monitor ‘or smart tv, computer/laptop V. Duration: 3 weeks VI. Lesson Proper : > ANNUITIES ‘An annuity is a series of equal payments occurring at equal periods of time. Symbols and their meaning P = value or eum of money at present MODULES ‘ABE0S6 — AB Engineering Economy 10f9F = value or sum of money at some future time A= a series of periodic, equal amounts of money = number of interest periods interest rate per interest period > Ordinary Annuity ‘An ordinary annuity is one where the payments are made at the end of each period Finding P_ n A is given [4.1] The quantity in brackets is called the uniform series present worth factor and designated as with functional symbol (P/A, i%,n). Hence, P =A (PIA, i%,n) Finding F when A is Given _,fator-1 4.21 r-a[e || 142] ‘The quantity in brackets is called the uniform series compound amount factor and designated as with functional symbol (F/A, i%,n). Hence, F=A (FIA, i%,n) 143] a=P| Gti | The quantity in brackets is called the capital recovery factor and designated with functional symbol (A/P, i%,n), thus A=P (AP, i%,n), Finding A when F is Given “=F lal 44 The quantity in brackets is called the sinking fund factor and designated with functional symbol (A/F, i%,n), thus A=P (AF, i%,n), lation AIP, i%,n and AVF, i%,n sinking fund factor + i = capital recovery factor [4.5] Examples 4.1 A recent goverment study reported that a college degree is worth an extra 23,000 per year in income compared to what a high-school graduate makes. If MODULE 4 .ABE0G6 - AB Engineering Economy 208the interest rate is 6% per year and you work for 40 years, what is the future compound amount of this extra income? SOLUTION: A F 23,000 per year % n= 40 years CFD: P 3,559,525.209 Examples 4.2 A micro-brewery is considering the installation of a newly designed boiler system that bums the dried, spent malt and barley grains from the brewing process. The boiler will produce process steam that powers the majority of the brewery's energy operations, saving P450,000 per year over the boiler's expected life of 10 years. If the interest rate is 12% per year, how much money can the brewery afford to invest in the new boiler system? SOLUTION: A = P450,000 n=10 i= 12% +2=6% P=? CFD: Company's viewpoint AA ' - ERannually = ERsemi-annually (1 +i)" =(1 + 0.06)? 0.1236, +0" = 450,00 [ P 2,505,565.315 MODULE ‘ABE056 — AB Engineering Economy 30f9> Deferred Annuity A deferred annuity is one where the first payment is made several periods after the beginning of the annuity. 1+ i P= Jaton 14.6) Examples 4.3 A father, on the day his son is bom, wishes to determine what lump amount would have to be paid into an account bearing interest of 12% per year to provide withdrawals of P20,000 on each of the son's 18th, 19th, 20th, and 21st birthdays. SOLUTION: A = P20,000 i=12% CFD: Poa [POO 4a-™ = 20,000 [22] 1 +>? = P 8.847.455 > Annuity Due An annuity due is on where the payments are made at the beginning of each period Finding P When A is Given P=A+A (PIA, i%, n-1) [4.7] P=A(1+PIA, 1%, n-1) Finding F When A is Given F =A (FIA, i%, n#1)-A [4.8] F=A[(F/A, 1%, n¥1) 1] Examples 4.4 MODULE + ‘ABEO56 — AB Engineering Economy 4o0foA farmer bought a tractor costing P2,500,000 payable in 10 semi-annual payments, each installment payable at the beginning of each period. If the rate of interest is 26% compounded semi-annually, determine the amount of each installment. SOLUTION: P = P2,500,000 n=10 i= 26% +2= 13% CFD: P =P 2,500,000 10 en fu 4g trasorey = s2(1:13) 2,500,000 = 4 [1 +E") A= P 407.720.2563 > Perpetuity and Capitalized Cost A perpetuity is an annuity in which the payments continue indefinitely. Pea 14.9] i One of the most important applications of perpetuity is in capitalized cost. The capitalized cost of any property is the sum of the first cost and the present worth of all costs of replacement, operation and maintenance for a long time or forever. Case 1._No replacement, only maintenance and or operation every period CC=FC+P cc=FC+* [4.10] Case 2. Replacement only, no maintenance and/or operation CC=FC+X _ s (4.11) Con=FC+ G+k-1 Case 3. Replacement, maintenance and/or operation every period MODULE4 ‘ABE0S6 — AB Engineering Economy 50f9cc=Fo+ port iato 14.12] where: CC = capitalized cost FC = first cost P = present worth of perpetual operation and/or maintenance X = amount if principal invested at rate i% the interest on which will amount to S every k periods S = amount needed to replace a property every k periods Q = present worth of perpetual operation T, U = amount needed for maintenance and/or operation every k periods Examples 4.5 f money is worth 8% compounded quarterly, compare the present value of the following: a. an annuity of 1,000 payable quarterty for 50 years b. an annuity of P1,000 payable quarterly for 100 years c. a perpetuity of P1,000 payable quarterly SOLUTION: i= 8% +4=2% a P=A[ES2") = 1,000 [EO b. P= A [ES") = 1,000 [EOE A _ 1000 Cad tor =P 50,000 P 49,047.35 =P 49,981.85 Examples 4.6 Compare the capitalized costs of the following road pavement: ‘An asphalt pavement costing P100,000 which would last for 5 years with negligible repairs. At the end of 5 years, P5,000 would be spent to remove the old surface before P100,000 is spend again for a new surface. A thick concrete pavement costing P250,000 which would last indefinitely, with @ cost of P20,000 for minor repairs at the end of every 3 years. Money is worth 8% compounded annually. SOLUTION: For the asphalt pavement: FC =P100,000 k=5 $= P5,000 + P100,000 = 105,000 i= 8% - se 105.000 CO= FC + ay = 100,000 + ASS =P 323,724.10 For concrete pavement: FC = P250,000 S=P20,000 ,k=3 CC = FC + 5 — = 250,000 + 2e- mr Gaara =? 327,008.38 Examples 4.7 MODULE ‘ABEOS6 ~ AB Engineering Economy 6otoA research Foundation wishes to set up a trust fund earning 10% compounded annually to (a) provide P2,000,000 for the lot and building and P1,000,000 for the initial equipment of a Structural Engineering and Materials Laboratory; (b) pay 400,000 for the annual operating costs every year; and (c) pay P500,000 for the purchased of new equipment and replacement of some equipment every 5 years beginning 5 years from now. How much money be paid into the fund for the building and equipment and to pay for perpetual operation and equipment replacement? SOLUTION: i= 10% FC = P2,000,000 + P1,000,000 = 3,000,000 A= P400,000 $= P500,000 k=5 cosFc+t+ = 3,000,000 + any 7 P 7,818,987.40 a > Amortization Amortization is any method of repaying a debt, the principal and interest included, usually by equal payments at equal intervals of time. Examples 4.8 A business man borrowed P10,000 with interest at the rate of 55 payable annually. The debt will be paid, principal and interest included, by equal payments at the end of each year for 3 years. Compute the annual payment and construct the amortization schedule. SOLUTION: P = P10,000 i= 5% n=3 Poa fra) 10,000 = 4 [-22*) A=P 3,672.09 Amortization Schedule Period | Principal @[ interest @ 5% | Annual Payment to _| beginning of period _| per period payments _| principal i 10,000.00 500.00 3,672.09 3172.09 2 [6827.91 341.39 3,672.09 3330.69 3 3497.22 174.86 _—‘| 3,672.09 3497.23, Total a 4,016.25, 11,016.27 | 10,000.07 The figures in the above amortization table were calculated as shown below: Period | Principal @ beginning of period | interest @ 5% per period | Annual | Payment to pinapal payments 70,000.00, T0000 x 006 = 50000 [3.67200 — | aera 00 600= 317200 10,000 - 317208 = 6827.91 | 6827.91 x 0.05 3,672.09 | 3,672.09~ 341.39 = 3330.69, i 2 3 __| 6827.94 - 3990.69 = 3497.22 | 3497.22 x 0.05= 3,672.09 | 3,672.00— 174.86 = 3407.23, Tolal : 1,016.25 11,016.27 | 10,000.07 MODULE+ ‘ABE056 — AB Engineering Economy Tots> UNIFORM ARITHMETIC GRADIENT Some problems involve receipts or expenses that are projected to increase or decrease by a uniform amount each period, thus constituting an arithmetic ‘sequence of cash flows. For example, because of leasing a certain type of equipment, maintenance and repair savings relative to purchasing the equipment may increase by a roughly constant amount each period. This situation can be modeled as a uniform gradient of cash flows. The symbol for the uniform gradient amount is G. Finding P When G is Given _pfift-a+o™ n pac fifo al a The term in braces is called the gradient to present equivalent conversion factor and designated with the functional symbol (P/G,i%,n). Hence, P= G (PIG, i%, n) Finding A When G is Given n = [4.14] Ane [i- a+o areal The term in brackets is called the gradient fo uniform series conversion factor and designated with the functional symbol (A/G, i%,n). Hence, A=G(AG, i%, n) - |} [4.15] Examples 4.9 ‘Suppose that the company has cash flows as follows: Finding F When G is n reoft a+i" End of | Cash Flows Year (P) “T5000 2 6,000 3 7,000 4 8,000 Calculate the present equivalent at i =15% per year. What is the annual equivalent of the original cash flows? SOLUTION: A= 5000 G=P 1000 i =15% n=4 MODULE 4 ‘ABEOS6 — AB Engineering Economy Bot% 4 G=mto0 #3000 P2000 1000 SHA sg fseueom np é i i ~ Gao +n. ~ ay]} =? 18,065 > 18,065=4 [82°] » a=P 6,326.30 035 VII. Activity ; Lecture, group discussions, seat work, problem sets, board work MODULE 4 ‘ABE056 — AB Engineering Economy 90fe