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ENGINEERING ECONOMY
Dr. Leonardo C. Medina, Jr.

INTEREST
1. Simple interest
F = P (1 + ni)
a) ordinary simple interest: one interest period = 360 days
b) exact simple interest: one interest period = 365 days
= 366 days
2. Compound interest
F 
F  P  , i, n   P 1  i 
n

P 
P 
P  F  , i, n   F 1  i 
n

F 
F 
 , i, n   1  i  = single payment compound amount factor
n

P 
 P 
 , i, n   1  i  = single payment present worth factor
n

F 

where: P = principal (present worth)

F = accumulated amount (future worth)
i = rate of interest per interest period
n = number of interest periods

Rates of interest

1. Nominal rate of interest

- specifies the rate of interest and the number of interest periods in a year

2. Effective rate of interest

ieff = (1 + i)n – 1
where n = number of interest periods in a year
if compounded continuously ieff = er – 1
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ANNUITY
1. Ordinary Annuity

P   1  i n  1 1  1  i  n 
P  A  , i, n   A  A  
A   i 1  i  
n
 i 

F   1  i n  1
F  A  , i, n   A  
A   i 

uniform series present worth factor=

 1  1  i 
n
P (1  i)n  1
 , i, n   
A  i 1  i 
n
i
A  i i (1  i )n
capital recovery factor =  , i, n   n

P  1  (1  i) (1  i) n  1

F  (1  i)  1
n
uniform series compound amount factor =  , i, n  
A  i
 A  i
sinking fund factor =  , i, n  
F  (1  i)  1
n

2. Deferred Annuity
P  P 
P  A  , i, n  , i, m 
A  F 
1  (1  i ) 
n

 1  i 
m
P  A
 i 

3. Perpetuity
A
P
i

4. Uniform Arithmetic Gradient

  l  i n  1  in 
P G 2 
 i  l  i 
n

G  (l  i ) n  1 
F   n
i  i 
5. Geometric Gradient

1  (1  i )  n (1  g ) n 
P  A1   ,i  g
 ig 
nA1
P ,i  g
1 i
 (1  i ) n  (1  g ) n 
F  A1  , i  g
 ig 
F  nA1 (1  i ) n 1 , i  g
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6. Annuity Due
P = A + A 1-(1+i)-n
i

CONTINUOUS COMPOUNDING AND DISCRETE CASH FLOW

1. Single Cash Flow
F = Pern
P = Fe-rn

2. Uniform Series (annuities)

F = A ern – 1
er – 1

P=A ern – 1
ern(er – 1)

where:
F = future equivalent
P = present equivalent
r = nominal annual rate of interest compounded continuity
n = number of periods
A = annual equivalent amount (occurs at the end of each year)

CONTINUOUS COMPOUNDING CONTINUOUS UNIFORM CASH FLOW

F=Ã ern – 1
r

P = Ã ern – 1
rern

where:
à = amount of money flowing continuously and uniformly during each period

BONDS
Methods of Bond Retirement

1. Using sinking fund

A+I=F i +r
(1 + i)n – 1
where:
(A + I) = total periodic expense
A = periodic deposit to the sinking fund
I = interest on bonds
r = bond rate
i = sinking fund interest rate
2. Issuing callable bonds (serial bonds)
r=i

A+I=F i +i
(1 + i)n – 1

A+I=F i = F i(1+i)n
1 – ( 1+ i) –n (1 + i)n - 1
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Bond Value

P = I 1 – (1+i) –n + C(1+i)-n
i

P = F.r 1 – (1+i) –n + C(1+i)-n

i

where:
P = value of bond n-periods before redemption
C = redemption price (disposal price = often equal to F)
F = face or par value
i = investment rate or yield per period

DEPRECIATION
Depreciation methods

I. Uniform methods

1. Straight line
V  Vs
d
n
a
Da  ad  V  Vs 
n
Va  V  Da

2. Sinking fund
V  Vs  i
d
(1  i ) n  1
 1  i a  1 
Da  (V  Vs )  
 (1  i)  1 
n

Va  V  Da

II. Non Uniform methods

1. declining balance
da  V (1  f ) a 1 . f
Va  V (1  f ) a
Vs
f  1 n
V
2. double declining balance
da  V 1  n2 
a 1 2
.
n
Va  V 1  n2 
a

3. Sum of the Years digit

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 n  a  1
da   n  V  Vs 
 2 (n  1) 
Va  V  Da  V  (d1  d 2  ...  da)
4. Output method
Qa
da  V  Vs  Va = V – Da = V – (d1 + d2 + d3 + ……+dn)
QT

5. Working Hours method

Ha
da  V  Vs  Va = V – Da = V – (d1 + d2 + d3 + ……+dn)
HT
where:
d = annual depreciation
V = original cost
Vs = salvage value
N = economic life
a = number of years in actual use
Da = accumulated depreciation
Va = asset (book) value
f = fixed percentage
Qa = number of units a machine can produce for period a
QT = number of units a machine can produce during its economic life
Ha = number of hours a machine is utilized for period a
HT = number of hours a machine is utilized during its economic life

EVALUATION OF ECONOMIC ALTERNATIVES

1. Rate of Return on Investment
Rate of Return = annual net profit
capital invested

% ROI = annual savings x 100

additional investment
total investment = depreciable fixed capital investment + working capital
2. Annual Worth (Annual Cost)
total annual cost = annual capital recovery + annual operating cost

TAC = (V –Vs) i + V.i + OC

(1 + I)n – 1

TAC = (V – Vs)i + Vs.i + OC

1 – (1 + i)-n

TAC = Vi _ Vsi + OC
1 – (1 + i)–n (1 + i)n – 1

TAC = straight line depreciation + average annual interest + OC

= V – Vs + (V – Vs) i n+1 + Vs.i + OC

n 2 n
3. Present worth
4. Future worth
5. Internal Rate of Return
PW cash inflow – PW cash outflow = 0
FW cash inflow – FW cash outflow = 0
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Solve for i by trial and error

6. Payout period ( Payback period)
Payout period = capital invested
net annual cash flow
7. Capitalized cost

P = first cost +
PW cost of perpetual + PW of cost of perpetual + PW of renewals
maintenance & operation replacement
P = V+ A + S + V – Vs
i (1 + i)k – 1 (1 + i)n – 1

where:
A = annual maintenance and operating cost
S = amount needed to replace a property every k-periods

8. Benefit Cost
B > 1.0
C
B = (B – C) (B/C) = B/ (C + I)
C I
net

where:
B = annual benefits
C = annual costs
I = initial investment
9. Equivalent Uniform Annual Cost
10. External Rate of Return

BREAK-EVEN
Break Even Analysis
- involves investment of capital wherein at a certain level of production the total income of the company would just be equal to
total expenses, thus resulting in no loss nor profit

Output at break-even = FC
SP - VC
U U
where:
FC = fixed cost
SP/U = selling price per unit
VC/U = variable cost per unit