Engineering Economy
Blank, L T., (2012), Engineering Economy (7th Edition), New York:
McGraw Hill, Chapter 1
Description and Role in Decision Making
Most decisions involve money, called capital or capital
funds, which is usually limited in amount. The decision of where
and how to invest this limited capital is motivated by a primary
goal of adding value as future, anticipated results of the selected
alternative are realized.
Description and Role in Decision Making
Since most decisions affect what will be done, the time frame of
engineering economy is primarily the future. Therefore, the
numbers used in engineering economy are best estimates of
what is expected to occur. The estimates and the decision
usually involve four essential elements:
• Cash flows
• Times of occurrence of cash flows
• Interest rates for time value of money
• Measure of economic worth for selecting an alternative
Description and Role in Decision Making
Performing an Engineering Economy Study
The steps in an engineering economy study are as follows:

1. Identify and understand the problem; identify the objective of

the project.
2. Collect relevant, available data and def ine viable solution
alternatives.
3. Make realistic cash flow estimates.
4. Identify an economic measure of worth criterion for decision
making.
Performing an Engineering Economy Study
The steps in an engineering economy study are as follows:

5. Evaluate each alternative; consider noneconomic factors; use

sensitivity analysis as needed.
6. Select the best alternative.
7. Implement the solution and monitor the results.
Interest and Money-Time Relationships
Interest – is the amount of money paid for the use of borrowed
capital (borrower’s viewpoint) or the income produced by money
which has been loaned (lender’s viewpoint).

F=P+I
Where:
I = interest
P = principal or present worth
F = accumulated amount or future worth
Interest and Money-Time Relationships
Cash-Flow Diagrams

Cash-Flow Diagram – is a graphical representation of cash f lows

drawn on a time scale.

↑ - receipt (positive cash flow or cash inflow)

↓ - disbursement (negative cash flow or cash outflow)
Interest and Money-Time Relationships
Cash-Flow Diagrams
Example: A loan of P100 at simple interest will become P150
after 5 years.

C ash f lo w d i agram o n t he C ash f lo w d i agram o n t he

viewpoint of the lender. viewpoint of the borrower.
Interest and Money-Time Relationships
Simple Interest Future Worth, F:
The interest earned F=P+I
by the principal is Interest earned, I:
computed at the end of the
I = Prt
investment period.
Where:
P = principal or present worth
r = simple interest rate (per year)
t = time in years of fraction of a
year
Interest and Money-Time Relationships
•
Interest and Money-Time Relationships
•
Interest and Money-Time Relationships
Simple Interest

Example 1:
Determine the ordinary simple interest on P 20,000 for 9
months and 10 days if the rate of interest is 12%.
Ans. P 1,866.67
Interest and Money-Time Relationships
Simple Interest

Example 2:
Determine the (a) ordinary and (b) exact simple interests on
P 100,000 for the period January 15 to June 20 2012 if
interest is 15%.
Ans. (a) P 6,541.67; (b) P 6434.43
Interest and Money-Time Relationships
Simple Interest

Example 3:
Calculated the exact interest on an investment of P
2,000.00 for a period from January 30 to September 15, 2001 if
the rate of interest is 10%.
Ans. P 124.93
Interest and Money-Time Relationships
Simple Interest

Example 4:
If P 4000 is borrowed for 75 days at 16% per annum. How
much will be due at the end of 75 days?
Ans. P 4133.33
Interest and Money-Time Relationships
Simple Interest

Example 5:
How long will it take for a deposit of P 1, 500.00 to earn P
186 if invested at the simple interest rate of 7 1/3%?
Ans. 1.6909 years
Interest and Money-Time Relationships
Simple Interest

Example 6:
If you borrow money from your friend with simple interest of
12%, f ind the present worth of P 20,000 at the end of 9
months.
Ans. P 18,348.60
Interest and Money-Time Relationships
Simple Interest

Assignment 1:
(CE Board) A deposit of P 110,000 was made for 31 days.
The net interest after deducting 20% withholding tax is P 890.36.
Find the rate of return annually.
Interest and Money-Time Relationships
Simple Interest

Assignment 1:
(CE Board) A deposit of P 110,000 was made for 31 days.
The net interest after deducting 20% withholding tax is P 890.36.
Find the rate of return annually.
Ans. 11.75%
Interest and Money-Time Relationships
Compound Interest
The interest earned is
computed every end of each
interest period (compounding
p e ri od ) and the i nte re st
e a rne d f o r t ha t p e ri o d i s
added to the principal.
Compound Interest
To compute values of i and n:
nominal interest rate = 12%
number of years of investment = 6 years

a. compounded annually d. compounded monthly

i= 0.12/1 = 0.12 i= 0.12/12 = 0.01
n = 6(1) = 6 n = 6(12) = 72
b. compounded semi-annually e. compounded bi-monthly
i= 0.12/2 = 0.06 i= 0.12/6 = 0.02
n = 6(2) = 12 n = 6(6) = 36
c. compounded quarterly
i= 0.12/4 = 0.03
n = 6(4) = 24
•
•
Interest and Money-Time Relationships
Compound Interest

Example 1:
The amount of P 20,000 was deposited in a bank earning
an interest rate of 6.5% per annum. Determine the total amount
at the end of 7 years if the principal and interest were not
withdrawn during this period.
Ans. P 31,079.73
Interest and Money-Time Relationships
Compound Interest

Example 2:
A man expects to receive P 25,000 in 8 years. How much is
that m o ne y w o r th no w c o nsi d e ri ng i nte re st at 8 %
compounded quarterly?
Ans. P 13,265.83
Interest and Money-Time Relationships
Compound Interest

Example 3:
How many years will P 100,000 earn a compounded
interest of P 50,000 if interest is 9% compounded quarterly?
Ans. 4.56 years
Interest and Money-Time Relationships
Compound Interest

Example 4:
A sum of P 1,000.00 is invested now and left for eight years,
at which time the principal is withdrawn. The interest has
accrued is left for another eight years. If the effective
annual interest rate is 5%, what will be the withdrawal amount
at the end of the 16th year?
Ans. P 705.42
Interest and Money-Time Relationships
Compound Interest

Example 5:
If money is worth 5% compounded quarterly, f in d the
equated time for paying a loan of P 150,000 due in one year
and P 280,000 in 2 years.
Ans. 1.6455 years
Interest and Money-Time Relationships
Compound Interest

Example 6:
How long will it take money to double itself if invested at
5% compounded annually?
Ans. 14.2 years
Interest and Money-Time Relationships
Compound Interest

Example 7:
Compute the equivalent rate of 6% compounded semi-
annually to a rate compounded quarterly.
Ans. 5.96% ≈ 6% compounded quarterly
Interest and Money-Time Relationships
Compound Interest

Example 8:
I f P 5 , 0 0 0 .0 0 shal l ac c um ul ate f or 1 0 ye ars at 8 %
compounded quarterly. Find the compounded interest at the
end of 10 years.
Ans. P 6,040.20
 Plates
Simple Interest
1. A man buys an electric fan from a merchant that charges
P1500.00 at the end of 90 days. The man wishes to pay cash.
What is the cash price if money is worth 10% simple interest?

2. What amount will be available in eight months if P 15,000.00 is

invested now at 10% simple interest per year?

3. P 1000.00 becomes P 1500.00 in three years. Find the simple

interest rate.

4. An engineer borrowed a sum of money under the following

terms: P 650,000.00 if paid in 90 days, or P 600,000.00 if paid in
30 days. What is the equivalent annual rate of simple interest?
 Plates
Compound Interest
1. By the condition of a will, the sum of P 2,000 is left to a girl to
be held in trust fund by her guardian until it amounts to P 5,000,
when will the girl received the money if the fund is invested at 8%
compounded quarterly?

2. A student plan to deposit P1, 500 in the bank now and another
P3, 000 for the next 2 years. If he plans to withdraw P5, 000 3
years after his last deposit for the purpose of buying shoes, what
will be the amount of money left in the bank after one year of his
withdrawal? Effective annual interest rate is 10%.

3. If the interest rate of a certain account is 6.5%, compute the (a)

single payment present worth factor; and (b) single payment
compound amount factor at the end of 18 years.
Interest and Money-Time Relationships
Continuous Compounding Interest

F = Pe rt

where: e is continuous compounded amount factor

rt

r = nominal rate of interest

t = number of years

Effective rate if compounded continuously, ER:

ER = e - 1
r
Interest and Money-Time Relationships
Continuous Compounding Interest

Example 1:
P 100,000 is deposited in a bank that earns 5%
compounded continuously. What will be the amount after 10
years?
Ans. P 164,872.13
Interest and Money-Time Relationships
Continuous Compounding Interest

Example 2:
Money is deposited in a certain account for which interest
is compounded continuously. If the balance doubles in 6 years,
what is the annual percentage rate?
Ans. 11.55%
Interest and Money-Time Relationships
Continuous Compounding Interest

Example 3:
A man wishes to have P 40,000 in a certain fund at the end
of 8 years. How much should he invest in a fund that will pay
6% compounded continuously?
Ans. P 24, 751.34
Interest and Money-Time Relationships
Continuous Compounding Interest

Example 4:
If the effective annual interest rate is 4%, compute the
equivalent nominal interest compounded continuously.
Ans. 3.922%
Interest and Money-Time Relationships
Continuous Compounding Interest

Example 5:
W hat i s the no m i nal rate o f i nte re st c o m p o und e d
continuously for 10 years if the compound amount factor is
1.34986?
Ans. 3%
Interest and Money-Time Relationships
Continuous Compounding Interest

Example 6:
Deposits of P35,000.00, P48,000.00 and P25,000.00 were
made in a savings account eight years, f ive years, and two
years ago, respectively. Determine the accumulate amount
in the account today if a withdrawal of P55,000.00 was made
f o u r y e a r s a g o . T h e a p p l i e d i n t e re s t ra t e i s 1 1 %
compounded continuously.
Ans. P 113,330.66
Interest and Money-Time Relationships
Discount
It is the difference between
the future worth of a certain
commodity and its present worth.

2 Types of Discount:
• Trade Discount – disc ou n t
offered by the seller to induce
trading.
• Cash Discount – is the
reduction on the selling price
offered to a buyer to induce him
to pay promptly.
Interest and Money-Time Relationships
Discount

D=F–P

where:
D = amount of discount
F = accumulated amount or
future worth
P = principal or present worth
Interest and Money-Time Relationships
•
Interest and Money-Time Relationships
Discount

Example 1:
Mr. T borrowed money from the bank. He receives from
the bank P 1,340 and promised to pay P 1,500 at the end of 9
months. Compute: (a) Simple interest rate; and (b) Discount
Rate.
Ans. (a) 15.92%; (b) 13.73%
Interest and Money-Time Relationships
Discount

Example 2:
Find the discount if P 2,000 is discounted for 6 months at
8% simple discount.
Ans. P 80
•
•
Interest and Money-Time Relationships
Inflation

Example 1:
A man invested P 130,000 at an interest rate of 10%
compounded annually. What will be the f inal amount of his
investment, in terms of today’s peso, after 5 years, if
inflation remains the same at the rate of 8% per year?
Ans. P 142,491
Interest and Money-Time Relationships
Inflation

Example 2:
What is the uninf lated present worth of a P 200,000 future
value in two years if the average inf lation rate is 6% and
interest rate is 10%.
Ans. P 147,107
 Plates
Continuous Compounding Interest
1. If money is invested at a nominal rate of interest of 8% for a
period of 4yrs. (a) What is the effective rate if it is compounded
continuously. (b) What is the value of the compound amount
factor if it is compounded continuously.
2. What is the nominal rate of interest compounded continuously
for 8 years if the present worth factor is equal to 0.6187835.
Inflation
1. If the inf la tion rate is 6%, cost of money is 10%, what interest
rate will take care of inflation and the cost of money.
2. In year zero, you invest P 10,000 in a 15% security for 5 years.
During that time, the average annual inf lation is 6%. How much,
in terms of year zero will be in the account at maturity.
 Plates
Discount
1. An engineer promised to pay P 36,000 at the end of 90 days.
He was offered a 10% discount if he pays in 30 days. Find the
rate of interest.
 Review Quiz
1. What is the principal amount if the amount of interest at the
end of 2 ½ years is P45,000 for a simple interest rate of 6%
per annum?
2. Which of the following has the greatest effective rate? Show
your solution per interest rate given.
a. 12.31% compounded quarterly
b. 12.20% compounded monthly
c. 12.35% compounded annually
d. 12.32% compounded semi-annually
3. A certain nominal annual interest rate has an effective rate of
19.722% when compounded continuously. What is its
effective rate if compounded bi-monthly?
Annuities
Ordinary Annuity
Ordinary Annuity – a type of annuity were equal payments are
made at the end of each period.

Annuity Due
Annuity Due – a type of annuity were equal payments are made at
the beginning of each period.

Deferred Annuity
Deferred Annuity – a type of annuity where the f irst payment is
made several periods after the beginning of annuity.
Annuities
Perpetuity
Perpetuity – a type of annuity in which payments continue
indefinitely.

Continuous Compounding for Discrete Payments

Continuous Compounding for Discrete Payments – an annuity
compounded continuously.
Ordinary Annuity
Ordinary Annuity – a type of annuity were equal payments are
made at the end of each period.
Ordinary Annuity
Ordinary Annuity
•
Ordinary Annuity
Where:

P = value or sum of money at present

A = series of periodic equal amount of payments
i = interest rate per interest period
n = number of interest periods/number of equal payments
P/A = uniform series present worth factor
A/P = capital recovery factor
Ordinary Annuity
Ordinary Annuity
Ordinary Annuity
Where:

F = value or sum of money at some future time

A = series of periodic equal amount of payments
i = interest rate per interest period
n = number of interest periods/number of equal payments
F/A = uniform series compound amount factor
A/F = sinking fund factor
Annuities
Ordinary Annuity

Example 1:
Find the annual payment to extinguish a debt of P 100,000
payable for 6 years at 12% interest annually.
Ans. P 24,322.57
Annuities
Ordinary Annuity

Example 2:
What annuity is required over 12 years to equate to a future
amount of P 200,000? i = 8%.
Ans. P 10,539.00
Annuities
Ordinary Annuity

Example 3:
Mr. Y bought a house and lot for $ 2,800,000 with a
downpayment of $ 300,000. Interest is 5% to be paid for 30
years on a monthly basis. Compute the amount of monthly
payment.
Ans. $ 13,420.54
Annuities
Ordinary Annuity

Example 4:
An annual payment is made for 10 years with an annual
interest rate of 8%. Compute the following:
(a) Uniform series present worth factor;
(b) Capital recovery factor;
(c) Uniform series compound amount factor;
(d) Sinking fund factor
Ans. (a) 6.710; (b) 0.149; (c) 14.487; (d) 0.069
Annuities
Ordinary Annuity

Example 5:
A piece of machinery can be bought for P 10,000 cash, or
for P 2,000 downpayment and payments of P 750 per year for 15
years. What is the annual interest rate of the time payments?
Ans. 4.6%
Annuities
Ordinary Annuity

Example 6:
If P500.00 is invested at the end of each year for 6 years, at
an annual interest rate of 7%, what is the total peso amount
available upon the deposit of the sixth payment?
Ans. P 3,576.65
 Plates
Ordinary Annuity
1. For having been loyal, trustworthy and ef fic ient, the company has
offered a superior a yearly gratuity pay of P 20,000.00 for 10 years
with the f ir st payment to be made one year after his retirement.
The supervisor, instead, requested that he be paid a lump sum on
the date of his retirement less interest that the company would
have earned if the gratuity is to be paid on yearly basis. If interest is
15%, what is the equivalent lump sum that he could get?

2. In anticipation of a much bigger volume of business after 10 years,

a fabrication company purchased an adjacent lot for its expansion
program where it hopes to put up a building projected to cost P
4,000,000.00 when it will be constructed 10 years after. To provide
for the required capital expense, it plans to put up a sinking fund for
the purpose. How much must the company deposit each year if
interest to be earned is computed at 15%?
Annuity Due
Annuity Due – a type of annuity were equal payments are made at
the beginning of each period.
Annuity Due
Where:

P = value or sum of money at present

F = value or sum of money at some future time
A = series of periodic equal amount of payments
i = interest rate per interest period
n = number of interest periods/number of equal payments
Annuities
Annuity Due

Example 1:
A man agrees to make equal payments at the beginning of
each 6 months for 10 years to discharge a debt of P 50,000
due now. If money is worth 8% compounded semiannually,
find the semiannual payment.
Ans. P 3,537.58
Annuities
Annuity Due

Example 2:
To accumulate a fund of P 80,000 at the end of 10 years, a
man will make equal annual deposits in the fund at the beginning
of each year. How much should he deposit if the fund is
invested at 5% compounded annually?
Ans. P 6,057.49
Annuities
Annuity Due

Example 3:
Determine the present worth and the accumulated amount
of an annuity consisting of 6 payments of P120, 000 each, the
payment are made at the beginning of each year. Money is
worth 15% compounded annually.
Ans. P = P 522,259; F = P 1,208,016
Annuities
Annuity Due

Example 4:
If money is worth 4% compounded semiannually, f ind the
p re se nt am o unt o f an annui ty d ue p ayi ng P 5 , 0 0 0
semiannually for a term of 3.5 years.
Ans. P 33,007.15
 Plates
Annuity Due
1. A farmer bought a tractor costing P 25,000 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.
2. A certain manufacturing plant is being sold and was submitted
for bidding. Two bids were submitted by interested buyers. The
f irst bid offered to pay P 200,000 each year for 5 years, each
payment being made at the beginning of each year. The second
bid offered to pay P 120,000 the f irst year, P 180,000 the second
year, and P 270,000 each year for the next 3 years, all payments
being made at the beginning of each year. If money is worth 12%
compounded annually, which bid should the owner of the plant
accept?
Perpetuity
Perpetuity – a type of annuity in which payments continue
indefinitely.

Where:
P = value or sum of money at
present
A = series of periodic equal
amount of payments
i = interest rate per interest
period
Annuities
Perpetuity

Example 1:
Find the present worth of perpetuity of P 5,200 payable
monthly if the interest is 16% compounded monthly.
Ans. P 390,000
Annuities
Perpetuity

Example 2:
Find the present value of a perpetuity of P 15,000 payable
semiannually if money is worth 8% compounded quarterly.
Ans. P 371,287
Annuities
Perpetuity

Example 3:
If money is worth 12% compounded quarterly, what is the
present value of the perpetuity of P1,000 payable monthly?
Ans. P100,993.78
Deferred Annuity
•
Deferred Annuity
•
Deferred Annuity
•
Deferred Annuity
•
Annuities
Deferred Annuity

Example 1:
A boy is entitled to 10 yearly endowments of P30,000 each
starting at the end of the eleventh year from now. Using an
interest rate of 8% compounded annually, what is the value
of these endowment now?
Ans. P93,241.98
Annuities
Deferred Annuity

Example 2:
A man invested P100,000 every end of the year for 10 years,
then waited for another 10 years for his money to grow. If
his investments earned 8% after tax compounded annually,
what would be the sum of his investments and earnings at the
end of the 20th year in pesos.
Ans. P 3,127,540.18
Annuities
Deferred Annuity

Example 3:
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 of 5% compounded annually, in order to
withdraw P 20,000 each on the child’s 18 th, 19 th , 20 th and
21th birthdays?
Ans. P 30,941.73
Annuities
Deferred Annuity

Example 4:
An asphalt road requires no upkeep until the end of 2 years
when P60, 000 will be needed for repairs. After this P90,
000 will be needed for repairs at the end of each year for the
next 5 years, then P120, 000 at the end of each year for the next
5 years. If money is worth 14% compounded annually, what
was the equivalent uniform annual cost for the 12-year
period?
Ans. P 79,245.82
 Plates
Perpetuity
1. If money is worth 8%, determine the present value of a
perpetuity of P 1,000 payable annually with the 1st payment due
at the end of 5 years.
2. It costs P 50,000 at the end of each year to maintain a section
of Kennon road in Baguio City. If money is worth 10%, how much
would it pay to spend immediately to reduce the annual cost by P
10,000?
 Plates
Deferred Annuity
1. A lathe for a machine shop costs P 60,000, if paid in cash. On
the i nstal l m e nt p l an, a p urc hase r sho ul d p ay P 2 0 , 0 0 0
downpayment and 10 quarterly installments, the f irst due at the
end of the f ir st year after purchase. If money is worth 15%
compounded quarterly, determine the quarterly installment.

2. A man invests P 10,000 now for the college education of his 2

year old son. If the fund earns 14% effective interest rate, how
much will his son get each year starting from his 18th to the 22nd
birthday?
Uniform Payment Series with Continuous Compounding

•
Uniform Payment Series with Continuous Compounding

•
Uniform Payment Series with Continuous Compounding

•
Annuities
Uniform Payment Series with Continuous Compounding

Example 1:
Determine the accumulated amount to an account paying P
5,000 annually (payments are made at the beginning of
each period) for 18 years if money is worth 8% compounded
continuously. Also determine the present worth.
Ans. P 209,452.57; P 49,625.13
Annuities
Uniform Payment Series with Continuous Compounding

Example 2:
Ryan invest P5,000 at the end of each year in an account
which gives a nominal annual interest of 7.5%, compounded
continuously. Determine the total worth of his investment at
the end of 15 years.
Ans. P 133,545.58
 Plates
Continuous Compounding for Discrete Payments
1. A boy deposited an amount of P600 each year in a local bank
that pays a nominal interest of “i”% per annum compounded
continuously. If he receives a total amount of P3323.81 after
% years,
a. Compute the value of “i”
b. What is the effective interest rate?

2. For a uniform series of payments, what is the value of

(P/A, 8%, 4) if it is compounded continuously.
Review Quiz
1. Find the value after 20 years in pesos of an annuity of P20,000
payable annually for 8 years, with the f irst payment at the end
of 2 years, if money is worth 5%.
2. 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?
3. What quarterly payment is required over 15 years to equate
with a future amount P150,000? Assume interest rate of 6%
compounded continuously.
4. With interest rate of 9% compounded continuously, what is the
present worth of a perpetuity of P8000 payable monthly?
Uniform Arithmetic Gradient
Uniform Arithmetic Gradient –
is the increase by a relatively
constant amount each period.

The cash f lo w above is equal to

the sum of the two cash f lo ws
Uniform Arithmetic Gradient
We denote the difference between two
preceding amount (increase per period)
as G, which is also known as uniform
gradient amount, in this case:
G = 500, n = 5
The formulas that may be used in this
type of cash f lo w may be analyzed
using this formulas:
Annuities
Uniform Arithmetic Gradient
Example 1:
An individual makes 5 deposits that increase uniformly by
P 300 every month in a savings account that earns 12%
compounded monthly. If the initial deposit is P 4,500,
determine the accumulated amount in the account just
after the last deposit.
Ans. P 25,984.67
Annuities
Uniform Arithmetic Gradient
Boardwork:

A contract has been signed to lease a building at P20,000

per year with an annual increase of P1,500 for 8 years. Payments
are to be made at the end of each year, starting one year from
now. The prevailing interest rate is 7%. What lump sum paid today
would be equivalent to the 8-year lease-payment plan?
Depreciation
• Depreciation – is the decrease in value of physical
property with the passage of time.
• Book Value – is the worth of property as shown on the
accounting records of an enterprise
• Salvage/Resale Value – is the price that can be
obtained from the sale of the property after it has been
used.
• Scrap Value – the amount of property would sell if
disposed of as junk.
Depreciation

Where:
BV = book value of a property at any time m
m

D = total depreciation of a property at any time m

m

D = total depreciation at the end of its useful life

L

FC = first cost
SV = salvage or scrap value
Depreciation
Straight Line Method Where:
S t ra i g h t L i n e M e t h o d –a d = depreciation at any year
method which assumes that Dm = total depreciation of a
the loss in value is directly property at any time m
proportional to the age of the
DL = total depreciation at the
property.
end of its useful life
L = useful life in years
FC = first cost
SV = salvage or scrap value
Depreciation
Straight Line Method
Example 1:
A machine has an initial cost of P 50,000 and a salvage
value of P 10,000 after 10 years. Using Straight Line
Method of Depreciation:
(a) What is the annual depreciation?
(b) What is the book value after 5 years?
(c) What is the total depreciation after 3 years?
Ans. (a) P 4,000; (b) P 30,000; (c) P 12,000
Depreciation
Straight Line Method
Example 2:
An Engineer bought an equipment for P 500,000. He spent
an additional amount of P 30,000 for installation and other
expenses. The salvage value is 10% of the f irst cost. If the
book value at the end of 5 years is P 291,500 using straight
line depreciation, compute the life of the equipment in
years.
Ans. 10 years
Depreciation
Straight Line Method
Example 3:
A machine which cost P 10,000 was sold as scrap after
being used for 10 years. The scrap value is P 500.
Determine the total depreciation at the end of 5 years.
Ans. P 4750
Depreciation
Straight Line Method
Example 4:
An equipment has a salvage value of P1M at the end of 50
years. The straight line depreciation charge is P2M.
(a) What is the first cost of the machine?
(b) What is the book value after 25 years?
(c) At what year will its total depreciation be P30M?
Ans. P 101M; P 51M; 15th year
 Plates
Straight Line Method
1. What is the book value of electronic test equipment after 8
years of use if it depreciates from its original value of P
120,000.00 to its salvage value of 13% in 12 years? Use straight-
line method.

2. The initial cost of paint sand mill, including its installation is,
P800 000.00. The BIR approved life of this machine is 10 years
for depreciation. The estimated salvage value of the mill is P
50,000.00 and the cost of dismantling is estimated to be P
15,000.00. Using straight line depreciation, what is the annual
depreciation charge and what is the book value of the machine at
the end of six years?
Depreciation
Sinking Fund Method
Sinking Fund Method – a
method which assumes that the
si nk i ng fu nd est a bl i sh ed i n
which funds will accumulate for Where:
replacement. d = depreciation at any year
Dm = total depreciation of a
property at any time m
The total depreciation that has
DL = total depreciation at the end
been taken place up to any given of its useful life
time is assumed to be equal to L = useful life in years
the accumulated amount in the
sinking fund at any time. FC = first cost
SV = salvage or scrap value
Depreciation
Sinking Fund Method
Example 1:
Given FC = 100,000, SV = 10,000, L = 10 years, i = 5%.
(a) Annual Depreciation, d.
(b) Book Value after 3 years.
(c) Book Value after 8 years.
Ans. P 7,155.41; P 77,442.56; P 31,672.21
Depreciation
Sinking Fund Method
Example 2:
An equipment cost P 100,000 with a salvage value of P 5,000
at the end of 10 years.
Using Sinking Fund Method with interest rate= 4%.
(a) Compute the annual depreciation cost.
(b) Find the book values at years 1 to 4.
Ans. (a) P 7,912.64;
(b) P 92,087.36; P 83,858.21; P 75,299.90; P 66,399.26
Depreciation
Sinking Fund Method
Example 3:
A plant erected to manufacture socks with a f irst cost of P
10,000,000 with an estimated salvage value of P 100,000 at
the end of 25 years. Find the appraised value to the nearest
100 by sinking fund method at 6% interest rate at the end of
a. 10 years
b. 20 years
Ans. P 7,621,600; P 3,362,200
 Plates
Sinking Fund Method
1. A factory is constructed at a 1st cost of P 8,000,000 and with
an estimated salvage value of P 200,000 at the end of 25 years.
Find its appraised value to the nearest 100 at the end of 10 years
by using sinking fund of depreciation assuming an interest of 5%.

2. A machine that costs P75 000.00 f ive years ago now cost P45
864.31, when 7% interest is applied using the sinking fund
formula. Determine the salvage value of the machine for an
estimated useful life of 10 years.
Depreciation
Declining Balance Method
(Matheson’s Method)
Declining Balance Method – a
method which assumes that Where:
the annual cost of dm = depreciation at any time m
d e p r e c i a t i o n i s a f ix e d BVm = book value of a property
percentage (k) of the salvage at any time m
value at the beginning of the Dm = total depreciation of a
year. property at any time m
L = useful life in years
Note : T hi s m e thod i s not FC = first cost
a p p l i c a b l e i f t h e re i s n o SV = salvage or scrap value
salvage value.
k = rate of depreciation
Depreciation
Declining Balance Method (Matheson’s Method)
Example 1:
A machine costing P 720,000 is estimated to have a book value
of P 40,545.73 when retired at the end of 10 years. Depreciation cost
is computed using a constant percentage of the declining value.
(a) What is the annual rate of depreciation?
(b) What is the book value after 3 years?
(c) What is the depreciation charge at the 4th year?
(d) What is the total depreciation after 6 years?
Ans. (a) 0.25; (b) P 303,750; (c) P 75,937.50; (d) P 591,855.47
Depreciation
Declining Balance Method (Matheson’s Method)
Example 2:
An equipment has a f irst cost of P500,000 and the cost of
installation is P30,000. If the salvage value is 10% of the
equipment cost at the end of its useful life of 5 yrs. Compute the
book value at the end of the 3rd year.
Ans. P 128,526.95
Depreciation
Declining Balance Method (Matheson’s Method)
Example 3:
A machine having a certain f irst cost has a life of 10 years
and a salvage value of 6.633% of the f irst cost at the end of 10
years. If it has a book value of P58,914 at the end of the 6th year,
how much is the f ir st cost of the machine if the constant
percentage of declining value is used in the computation for its
depreciation. (Sometimes called Matheson’s method)
Ans. P 300,000
Depreciation
Declining Balance Method (Matheson’s Method)
Example 4:
A machine costing P720,000 is estimated to have a life of
10 yrs. If the annual rate of depreciation is 25%, determine the
total depreciation using a constant percentage of the declining
balance method.
Ans. P 679,454.27
 Plates
Declining Balance Method (Matheson’s Method)
1. A radio service panel truck initially costs P 56,000. If resale
value at the end of the f if th year is estimated at P 15,000. By
means of the Declining Balance Method, determine the yearly
depreciation charge for the first and second years.

2. An engineer bought an equipment for P 800,000. Other

expenses, including installation, amounted to P 50,000. At the
end of its estimated useful life of 10 years, the salvage value will
be 10% of the f irst cost. Using the constant percentage method
of depreciation, what is the book value after 5 years?
Depreciation
Double Declining Balance Where:
Method dm = depreciation at any time m
Double Declining Balance BVm = book value of a property
Method – a method which is at any time m
similar to declining balance
method except that the rate of Dm = total depreciation of a
depreciation k is replaced by property at any time m
2/L. L = useful life in years
FC = first cost
Depreciation
Double Declining Balance Method
Example 1:
A machine has a f irst cost of P 140,000 and a life of 8
years with a salvage value of P 10,000 at the end of its
useful life. Using double declining balance method:
(a) What is the Book Value on the 3rd year?
(b) What is the depreciation charge on the 4th year?
Ans. P 59,062.50; P 14,765.63
Depreciation
Double Declining Balance Method
Example 2:
A lathe machine has an estimated salvage value of P10,000
at the end of its useful life of 8 yrs. Compute the f irst cost of the
machine if the total depreciation at the end of 4th year using
double declining balance method is P957,031.25.
Ans. P1,400,000
Depreciation
Double Declining Balance Method
Example 3:
An equipment worth P5,000 has an anticipated salvage
value of P500 at the end of its 5 year depreciable life. Compute
the depreciation of the equipment on the 3rd year only using DDB
method.
Ans. P 720
Depreciation
Double Declining Balance Method
Example 4:
A certain machine cost P400,000 and has a life of 5yrs and
a salvage value of P50,000 at the end of its expected life.
Compute the depreciation on the 3rd year using double declining
balance method.
Ans. P 57,600
Depreciation
Double Declining Balance Method
Example 5:
A machine cost P100,000 and has a salvage value of
P5,000 after its useful life of 25 yrs. Compute the book value
after 8 yrs using double declining balance method.
Ans. P 51,321.89
 Plates
Double Declining Balance Method
1. An earth moving equipment that cost P 90,000 will have an
estimated salvage value of P18,000 at the end of 8 years.
Using double-declining balance method, compute the book
value and total depreciation at the end of 5th year.
2. Cost of machine = P1,400,000
Useful life = 8 yrs
Salvage value = P10,000
Determine the 4 th year depreciation using double declining
balance method.
Depreciation
Sum of the Years Digit Method Where:
dm = depreciation at any time m
Dm = total depreciation of a
property at any time m
L = useful life in years
FC = first cost
SV = salvage or scrap value
Depreciation
Sum of the Years Digit Method
Example 1:
An asset is purchased for P 9000. Its estimated life is 10
years, after which is will be sold for P 1,000. Using SOYD
(a) Find the book value during the 3rd year.
(b) Find the depreciation during the 2nd year.
(c) Find the total depreciation after 4 years.
Ans. P 5,072.72; P 1,309.09; P 4,945.45
Depreciation
Sum of the Years Digit Method
Example 2:
The f irst cost of a machine is P1,800,000 with a salvage
value of P300,000 at the end of its life at 5 yrs. Determine the
total depreciation after 3 yrs using SOYD Method.
Ans. P 1,200,000
Depreciation
Sum of the Years Digit Method
Example 3:
A machine cost P7,350 has a life of 8 years and has a
salvage value of P350 at the end of 8 years. Determine its book
value at the end of 4 years using SOYD Method.
Ans. P 2294.44
Depreciation
Sum of the Years Digit Method
Example 4:
A telephone company purchased a microwave radio
equipment for P6M. Freight and installment charges amounted to
3% of the purchased price. If the equipment shall be depreciated
over a period of 8 yrs with a salvage value of 5%. Determine the
depreciation charge during the 5th year using the sum of the years
digit method.
Ans. P 652,333.33
Depreciation
Sum of the Years Digit Method
Example 5:
ABC Corporation makes its policy that for every new
equipment purchased, the annual depreciation should not exceed
20% of the first cost at any time without salvage value. Determine
the length of service if the depreciation used is the SOYD Method.
Ans. 9 yrs
 Plates
Sum of the Years Digit Method
1. A company purchases an asset for P 10,000.00 and plans to
keep it for 20 years. If the salvage value is zero at the end of the
20th year:
(a) What is the depreciation in the third year?
(b) What is the total depreciation at the end of 14 years?
(c) What is the book value of the asset at the end of 8 years?
Use sum-of-the-year’s digits depreciation.

2. A certain equipment costs P7,000 has an economic life of “n”

years and a salvage value of P350 at the end of “n” years. If the
book value at the end of 4 years is equal to P2197.22, compute
the economic life of the equipment using the SOYD Method.
Depreciation
Service-Output Method

Where:
Service-Output Method – a
method which assumes that Dm = total depreciation of a
the total depreciation that has property at any time
taken place is directly FC = first cost
proportional to the quantity of SV = salvage or scrap value
output of the property up to
that time. T = total units of output up to the
end of its life
Q = total number of units of
output at any time
Depreciation
Service-Output Method
Example 1:
An asphalt and aggregate mixing plant having a capacity of
50 cu.m. every hour costs P 2,500,000. It is estimated to process
800,000 cu.m. during its life. During a certain year it processed
60,000 cu.m. If its scrap value is P 100,000, determine the total
depreciation during the year and the depreciation cost chargeable
to each batch of 50 cu.m. using the service output method.
Ans. P 180,000.00; P 150.00
Depreciation
Service-Output Method
Example 2:
An equipment cost P480,000 and has a salvage value of
10% of its cost at the end of its life of 36,000 operating hours in a
period of 5 years. In the f irst year of service, it was used for
12,000 hours. If at the end of the second year it was used for
15,000 hours, find the depreciation at the end of the second year.
Ans. P 180,000
Depreciation
Working Hours Method
Example 3:
A machine was purchased at an original cost of P400,000
with a salvage value of P20,000. Life of this machine is expected
to last for 6 years. It was used for 4000 hrs in the f irst year, 6000
hrs in the second year, and 8000 hrs in the third year. The machine
is expected to last for 38,000 hrs in a period of 6 yrs. Find the
depreciation at the end of the second year.
Ans. P 60,000
Constant Unit Method
Example 4:
A coin machine costing P200,000 has a salvage value of P20,000
at the end of its economic life of 5 years. The schedule of production per
year is as follows:
Year Number of Coins
1 100,000
2 80,000
3 60,000
4 40,000
5 20,000
Determine the annual reserve for depreciation for 3rd year only.
Ans. P 36,000
Depreciation
•
Depreciation
Modified Accelerated Cost Recovery System, MACRS
Example 1:
The cost of equipment is P500,000 and the cost of
installation labor, taxes and miscellaneous expenses is P30,000.
If the salvage value is 10% of the cost of equipment at the end of
its life of 5 years, compute the book value at the end of third
year using MACRS Method.
Ans. P 152,640
Depreciation
Modified Accelerated Cost Recovery System, MACRS
Example 2:
A certain machine cost P400,000 and has a life of 5 years
and a salvage value of P50,000 at the end of its expected life.
Compute the depreciation on the 3 rd year using Modif ie d
accelerated cost recovery system.
Ans. P 76,800
End of Depreciation
Review Quiz (1 whole)
A machine costs P 8,000 which last for 7 years with a salvage
value at the end of its life of P 355. Determine the depreciation
charge during the 4th year and the book value at the end of 4
years by:
(a) Straight Line Method;
(b) Declining Balance Method;
(c) SOYD Method;
(d) Sinking Fund Method with interest of 12%;
(e) Double Declining Balance Method
 BASIC METHODS
FOR ECONOMY STUDIES AND
COMPARING ALTERNATIVES
EXAMPLES

Example 1:
A broadcasting corporation was formed duly approved by
the Securities and Exchange of fice has a working capital of P 20
M and a f ixed capital of P 80 M. Annual depreciation amounts to
P 5 M and expected annual prof it is P 16 M. Determine the
recovery period in years.
Ans. P 6.25 M
EXAMPLES

Example 2:
A f ix ed capital investment of P 10 M is required for a
proposed manufacturing plant and an estimated working capital
of P 2.5 M. Annual depreciation is 10% of the f ix ed capital
investment. Which of the following gives the payout period in
years?
Ans. 2.86
EXAMPLES

Example 3:
A f ix ed capital investment of P 10 M is required for a
proposed manufacturing plant and an estimated working capital
of P 2 M. Annual depreciation is 10% of the f ix ed capital
investment. If the annual prof it is P 2.5 M, what is the rate of
return?
Ans. 20.83%
EXAMPLES

Example 4:
Candy bars are sold in a local store for 50 cents each. The
factory has P1000 in f ix ed cost plus 10 cents of additional
expenses for each candy bar made. Assuming all candy bars
manufactured can be sold, find the break-even point.
Ans. 2500 candy bars
EXAMPLES

Example :5
The cost of producing a small transistor radio set consists
of P 23.00 for labor and P 37.00 for materials. The f ixed charges
in operating the plant are P 100,000 per month. The variable cost
is P 1.00 per set. The radio set can be sold for P 75.00 each.
Determine how many sets must be produced per month to break-
even.
 Review Problems

SITUATION 1
In his request to defer his payment, a man was ask to pay
P34,317.60 after 60 days for an appliance whose cash price is
P32,580.00. What simple interest rate was charged to him?

SITUATION 2
An engineer promised to pay P380,000 at the end of 120
days. He was offered 12% discount if he pays in 45 days. Find the
simple interest rate.
 Review Problems

SITUATION 3
What is the principal amount if the amount of interest at the
end of 2 ½ years is P45,000 for a simple interest rate of 6% per
annum?

SITUATION 4
How many years are required for an amount of money to
quadruple if it is invested at 4% interest rate?
 Review Problems

SITUATION 5
A certain nominal annual interest rate has an effective rate
of 19.722% when compounded continuously. What is the
effective rate if compounded bi-monthly?

SITUATION 6
How often must a nominal rate of 18% be compounded in
order to yield 18.81% annually?
 Review Problems

SITUATION 7
The effective rate on 25% compounded daily is nearest to
____.

SITUATION 8
A person borrowed P500,000 at an interest rate of 18%
compounded monthly. Monthly payments of P16,710 are agreed
upon. The length of the loan in months is closest to ____.
 Review Problems

SITUATION 9
What quarterly payment is required over 15 years to equate
with a future amount P150,000? Assume interest rate of 6%
compounded continuously.

SITUATION 10
A man invests P750,000 in a 6% account today. What
uniform annual withdrawal can he make for 6 years starting 15
years from now?
 Review Problems

SITUATION 11
Find the present worth of perpetuity of P5200 payable
monthly if the interest is 16% compounded monthly.

SITUATION 12
A man borrowed P200,000 from his friend and agreed to
pay after 6 years at an interest rate of 10% per annum. How much
should the man deposit monthly in a bank in order to discharge
his depth, if the bank offers 6% annual interest rate?
 Review Problems

SITUATION 13
Given the following data for construction equipment:
Initial Cost = P1,200,000.00
Economic life = 12 years
Estimated Salvage Value = P320,000
Determine the book value after seven years using:
a) SOYD
b) DDBM
c) Sinking Fund Method using 6% interest