ENGINEERING ECONOMY

Economics – one of the social sciences which consists of that body of knowledge dealing with
people and their assets and resources.
- is the sum total of knowledge which treats of the creation and utilization of
goods and services for the satisfaction of human wants.

Engineering Economy – a branch of economics which involves the application of definite laws
of economics, theories and investments and business practices to engineering problems
involving cost.
- also involves the study of cost features and other financial data and their
application in the field of engineering as bases for decision.
- also be considered to mean the study of economic problems with the concept of
obtaining the maximum benefits at the least costs.

Reason/s for Studying Engineering Economy:

1) Engineers, as a group, have wrought immense changes in improving the economic well-
being of mankind through their inventions and their application of scientific principle to
the varied problems of industry.
2) In the professional life of engineers, it is readily observed that the most successful ones
are those who gradually divorced themselves from the technical aspects of engineering
and who devote their time and efforts to financial problems related to engineering
work.

Important Uses and Applications of Engineering Economy:

1) Seeking of new objectives for the applications of engineering.
2) Discovery of factors limiting the success of a venture or an enterprise.
3) Analysis of possible investment of capital.
4) Comparison of alternatives as a basis for decision.
5) Determination of bases for decision.

ENGINEERING ECONOMY TECHNIQUES

Three basic steps for a complete analysis of a proposed project are:
1) The economy analysis – consider all factors affecting the economy of the project which
can be reduced to specific monetary values. It determines the initial costs of the project,
the costs for operation and maintenance, the needing working capital, the probable
income of the project when operational, the rate of return of the investment and all
other cost factors of the project.
 2) The financial analysis – the determination of the methods and sources of financing the
project, either through equity capital or borrowed capital, or a combination of both. It
tries to discover the best methods of financing the project to the extent of the amount
obtained in the economy analysis. The financial analysis follows the economy analysis
since it is dependent upon the latter for necessary data.

3) The intangible analysis – determines all aspects of the project which cannot be reduced
to monetary values and considers the uncertainty and the risk inherent in the project.
Its scope includes the so-called judgement of responsible person/s involved in the
project.
Note: All of these analyses should be made, studied and correlated with one another to form a
sound basis for the decision to implement the project or not. If these analyses are all
favourable, then the decision in favour of the proposal is not difficult to make.

BASIC TERMS
1) Tangible factors – are those which can be expressed in terms of monetary values.

2) Intangible factors – are those which are difficult or impossible to express definitely in
terms of monetary values. It is also called as Irreducible Factors.

3) Competition – occurs when a certain product is offered for sale by many vendors or
suppliers and there is no restriction against other vendors from entering a market.

4) Monopoly – occurs when a unique product/s or service/s is available only from a single
supplier and entry of all other possible suppliers is prevented.

5) Oligopoly – occurs when there are few suppliers and any action taken by anyone of
them will definitely affect the course of action of the others.

6) Price ( Good or Commodity ) – is defined to be as the amount of money or its

equivalent which is given in exchange for it. It regulates production, if prices go up,
production will increase and if price decreases, the production will also decrease.

7) Market – defined to be the place where sellers and buyers come together.
a) Local Market – a limited locality where certain goods such as those which are
perishable are sold.
b) National Market – certain goods sold all over the country.
c) World Market – goods that are exported to other countries.

8) Consumer Goods – goods that are consumed or used directly by people or are things
and services which serve to satisfy human needs.

9) Producers Goods – those which produce goods and services for human consumption.
These are instrumental in producing something or furnishing service for people.

10) Demand – is the quantity of a certain commodity that is bought at a certain price at a
given place and time.
LAW OF DEMAND – the demand for a commodity varies inversely as the price of the
commodity, though not proportionately.

P
R

D E M A N D

ELASTICITY OF DEMANDS:
a) Elastic Demand occurs when a decrease in selling price will cause a greater than
proportionate increase in the volume of sales.
b) Inelastic Demand occurs when a decrease in selling price will cause a less than
proportionate increase in the volume of sales.
c) Unitary Elasticity occurs when the mathematical product of price and volume of sales
remains constant regardless of any change in price.

11) Utility – defined to be as the capacity of a commodity to satisfy human wants. Demand
varies directly as the utility.

LAW OF DIMISHING UTILITY – an increase in the quantity of any good consumed or acquired by
an individual will decrease the amount of satisfaction derived from that good.
- To increase the utility of any commodity, it should be different from other similar
commodities. Thus, manufacturers of similar goods vary the styles, the size and the
usage of the goods they manufactured.

12) Marginal Utility – is the utility of the last unit of the same commodity which is
consumed or acquired.

13) Marginal Unit – the last unit of similar commodities consumed or acquired.

14) Supply – is the quantity of a certain commodity that is offered for sale at a certain price
at a given place and time.
LAW OF SUPPLY – the supply of a commodity varies directly as the price of the commodity,
though not proportionately.

P
R
I
C
E

S U P P L Y

LAW OF SUPPLY AND DEMAND – when free competition exists, the price of a product will be
that value where supply is equal to the demand.

P
R
I
C
E Price

S U P P L Y and D E M A N D

LAW OF DIMINISHING RETURNS – when one of the factors of production is fixed in quantity or
is difficult to increase. Increasing the other factors of production will result in a less than
proportionate increase in output.

15) Marginal Revenue – is the amount received from the sale of an additional unit of a
product.

16) Marginal Cost – is the additional cost of producing one more unit.

For free competition, the number of units produced that will give maximum profit is that for
which marginal revenue and marginal cost are equal.
EFFICIENCY

a) Physical efficiency =

A common measure of financial/physical efficiency is the:

Rate of Return =

b) Economic efficiency =

A common measure of economic efficiency is the:

Pay-Out Period =

NOTE: Perfection is a human ideal worth striving for. However, in the practical world,
compromise from perfection is usually the rule. Complete quality control of all the units
produced by a factory is to be desired, but it will definitely increase the cost of manufacturing,
such as that goods are priced out of the market.

PRESENT ECONOMY – it involves the analysis of problems for manufacturing a product or

rendering a service based on present or immediate costs. It occurs when effects of time such as
interest and depreciation are negligible. Present Economy analysis is employed when the
alternatives to be compared will provide the same result and the length of time involve in the
study is relatively short.

Present Economy studies occur in the following situations:

1) Selection of material.
2) Selection of methods to be used.
3) Selection of design.
4) Selection of site location for a project.
5) Comparison of proficiency among workers.
6) Economy of tool and equipment maintenance.
7) Economy of number and utilization of workers.
INTEREST AND DISCOUNT

Interest – amount of money paid for the use of borrowed capital. It is also the income
produced by the money which was lent.

A) Simple Interest – if the interest to be paid is directly proportional to the length of time
the amount or principal is borrowed.

1) Ordinary Simple Interest – is computed on the basis of one banker’s year.

1 banker year = 12 months with 30 days each = 360 days

2) Exact Simple Interest – based on the exact number of days, 365 days for an ordinary
year and 366 for a leap year.

Principal – the amount of money borrowed and on which interest is charged.

Rate of Interest – the amount earned by one unit of principal during a unit of time.

I = Pin F = P + I

Where: I – total interest earned by the principal.

P – amount of the principal.
I – rate of interest expressed in decimal form.
n – number of interest period ( one year )
F – is the total amount to be paid.

If d is the number of days in the interest period, then:

OSI = Pi ( d/360 )

ESI = Pi ( d/365 ) for ordinary year

= PI ( d/366 ) for a leap year
Examples:

1) A deposit of P10,000.00 was made today earning a simple interest rate of 12%. How
much money would be on this account after a period of six months and fourteen days it
was deposited?
Solution:
Since no exact dates are given, therefore it is an ordinary simple interest.
n = ( 6 x 30 ) + 14 = 194 days

F = P + I = P ( 1 + in ) = P10,000.00 [ 1 + ( 0.12 ) ( )]

F = P 10, 646. 67

2) How long can an investment be tripled if it earns a rate of simple interest of 15% ?
Solution:
If P is the present value, then future value is 3P.

F = P ( 1 + in ) ; 3P = P [ 1 + 0.15 ( n ) ] ; 3 = 1 + 0.15n
2 = 0.15n ; n = 13.33 years or 4800 days

3) A certain amount of money earns an interest of P1,125.00 after two years and a half
once invested on a fund earning a simple interest of 10%. How much amount of money
was invested on this fund?
Solution:
I = Pin ; P1,125.00 = P ( 0.1 ) ( 2.5 ) thus:
P = P4,500.00

4) A student deposited an amount of P25,000.00 last November 14, 2019 on a bank that
earns a simple rate of interest of 14%. If no withdrawals take place until August 18,
2020, how much interest does the amount accrued?
Solution:
Notice that there are given dates on the problem, thus we need to used exact simple
interest. But 2019 is an ordinary year and 2020 is a leap year, we have to separate days for such
years. From November 14, 2019 until December 31, 2019, there are a total of 47 days ( Nov. 14
not counted but Dec. 31 counted ) and from January 1, 2020 till August 18, 2020 there are 231
days ( includes Aug. 18 ). Therefore:

I = Pin = P25,000.00 [ ( 0.14 ) ( + ) ] = P2,659.70

Exercises:

1) A government employee invests an amount of P150,000.00 on a fund that earns a

simple rate of interest of 11%. If it is to mature after 5 years, how much amount of
money can be withdrawn from this fund after the said maturity?

2) What rate of simple interest would a certain amount be doubled once invested on an
account after two years, seven months and twelve days?

3) A certain amount of money was deposited on a bank that earns a simple rate of interest.
It was found out that after two years of deposit without any withdrawals take place, the
amount of money on the account becomes P 94,400.00 and total interest after five
years of deposits is P 36,000.00. Find the principal amount and the rate of simple
interest?

4) A student deposited an amount of P15,000.00 on a bank that earns a simple rate of

interest of 12% last June 14, 2019. The student again deposited an amount of
P25,000.00 last November 16, 2019 and withdrew an amount of P17,000 for personal
purposes last February 7, 2020. An amount of P32,500.00 was then deposited by the
student on his same account last May 23, 2020. After such, no other transactions take
place until the student decided to withdrew all of his money last August 27, 2020. How
much total amount of money was withdrawn from the sais account?

5) A P125,000.00 was invested on a fund last June 12, 2019 earning a simple rate interest
of 14%. Approximately, what exact date should this amount be withdrawn from the
fund ( assuming no other withdrawals take place ) so that the interest incurred totals an
amount of P 14,466.35?
 B) Compound Interest – the interest earned by the principal is not paid at the end of each
interest period, but is considered as added to the principal and therefore will also earn
interest for the succeeding periods.

Nominal Rate of Interest – specifies the rate of interest and the number of interest periods per
year.
Example: 12% compounded monthly

Effective Rate of Interest – is the actual rate of interest on the principal for one year.
Example: 14% compounded annually/ yearly or 14% effective.

ERI = [ ( 1 + i )n - 1 ] x 100%

Where i is the nominal rate of interest and n is the number of interest period.

Cash Flow:

0 1 2 …………. n

P = F ( 1 + i ) –n and F = P(1+i)n

Where: P is the present value of the said amount.

F is the future value of the said amount.
Continuous Compounding – if r is the nominal annual interest and m is the number of interest
period each year, then the interest rate per interest period is i = r/m and the number of
interest periods in n years is mn. Thus:

F = P ( 1 + r/m )mn

Increasing m, the number of interest periods per year without limit, it becomes very large and
approaches infinity and r/m approaches zero.

F = P lim ( 1 + r/m ) ; m approaches infinity

Set r/m = x; then m = ( 1/x )r and mn = ( 1/x )rn. As m approaches infinity, x approaches zero,
thus;

F = P [ lim ( 1 + x )1/x ]rn ; x approaches zero.

From Calculus, lim( 1 + x ) 1/x = 2.71828……….. = e

Thus, F = Pern

Discount – on a negotiable paper, is the difference between what is worth in the future and its
present worth, thus;

Discount = Future value - Present value

Rate of Discount – is the discount on one unit of principal per unit of time.

d = and i =

where i is an effective rate of interest.

Examples:

1) If the rate of interest of a certain amount deposited on an account is 14% compounded

quarterly, what is the effective rate of interest?
Solution:
.
ERI = [ ( 1 + )4 - 1 ] x 100% = 14.75%

2) What equivalent rate compounded quarterly is equivalent to 12% compounded semi-

annually?
Solution:
.
( 1 + )2 - 1 = ( 1 + )4 - 1

( 1 + )2 = 1.12550881 ; 1 + = 1.0609

i = .1218 or 12.18% compounded quarterly

3) How long will an amount be doubled if invested on a fund earning 12% compounded
quarterly?
Solution:
.
F = P ( 1 + i )n ; 2P = P ( 1 + )n ; 2 = ( 1.03 )n

ln ( 2) = n ln( 1.03 ) ; n = 23.45 quarters or 5.86 years

4) A P150,000.00 loan is to be paid in three instalments for a period of one year earning an
interest rate of 10% effective. The first payment happens three months after the said
loan was released amounting to P75,000.00. The second payment happens five months
after the first payment amounting to P 52,000.00. Last payment happens a year after
the loan was released. Find the amount of the last payment.
Solution:
Cash Flow Diagram:

150,000.00

3 8 12
52,000.00
75,000.00 X
Using n in years and using the effective rate of interest:

Let the present worth be your focal point ( reference point ) , thus:

P150,000.00 = P75,000.00 ( 1 + 0.10 ) + P52,000.00 ( 1 + 0.10 ) + X ( 1 + 0.10 )

P150,000.00 = P73,234.06 + P48,798.70 + 0.9091X
X = P30, 763.66

Let the future worth be your focal point, thus:

P150,000.00 ( 1 + 0.1 ) = P75,000.00 ( 1 + 0.1 ) + P52,000.00 ( 1 + 0.1 ) + X

P165,000.00 = P80,557.46 + P53,678.57 + X
X = P30,763.97

Using n in months and interest is nominally at compounded monthly:

0.10 = ( 1 + )12 - 1 ; i = 9.57 compounded monthly

Let the present worth be the focal point, thus:

. . .
P150,000.00 = P75,000 ( 1 + )-3 + P52,000 ( 1 + )-8 + X ( 1 + )-12

P150,000.00 = P73,233,87 + 48,798.36 + 0.9091X

X = P30,764.24

Let the future worth be the focal point, thus:

, . .
P150,000 ( 1 + )12 = P75,000 ( 1 + )9 + P52,000 ( 1 + )4 + X

P165,001.69 = P80,558.08 + P53,678.75 + X

X = P30,764.86
 5) A business loan was approved amounted to P 2.5 million by a Credit Agency in which it is
discounted at 8%. This loan needs to be paid in four instalment payments in different
amounts within a period of one year. First payment happens two months after the
release of the loan. Second payment is P50,000.00 greater than the first payment and
happens four months after the first payment. Third payment is P75,000 larger than the
second payment and happens three months after the second payment. Fourth and last
payment is P25,000 lesser than the first payment and happens a year after the said loan
was released. Find the amount of the third payment.
Solution:
Find first the effective rate of interest:
.
i = x 100% ; i = .
x 100% = 8.7%

Cash Flow Diagram:

P 2.5M

n in years i = 8.7%

2 6 9 12

X – P25,000
X
X + P50,000
( X + P50,000 ) + P75,000

Using Present worth as focal point:

P2,500,000 = X ( 1 + 0.087 ) + ( X + P50,000 ) ( 1 + 0.087 ) +

( X + P125,000 ) ( 1 + 0.087 ) + ( X - P25,000 ) ( 1 + 0.087 )

P2,500,000.00 = 0.9862X + 0.9591X + P47,957.36 + 0.9394X + P117,418.86

+ 0.92X - P22,999.08
X = P2,357,622.86 / 3.8047 = P619,660.65
Thus; third payment = P619,660.65 + P125,000.00 = P744,660.65
Exercises:

1) If the effective rate of interest is 15%, what equivalent rate would it be if:
a) compounded semi-annually?
b) compounded quarterly?
c) compounded monthly?

2) Which is better, borrow money on a Bank that earns an 12.5% compounded monthly or
on a Cooperative that earns an interest rate of 12.7% compounded semi-annually?

3) A certain amount of money becomes P111,446.05 five years from now and becomes
P165,602.97 ten years from now once invested on an account that earns a compound
interest. If this amount was invested three years ago on an account that earns an
effective rate,
a) what was the principal amount invested?
b) what was the equivalent rate of interest compounded quarterly?
c) what amount of money would this account will have seven years from now?

4) A certain property was purchased at an instalment basis wherein the buyer needs to
pay 30% of the cash price as down payment. Remaining balance be paid within the
period of two years in four payments at the end of every semi-annual. The first payment
amounts to P525,000.00, second payment amounts to P600,000.00, third payment
amounts to P470,000.00 and the last payment at an amount of P385,500.00. If money is
worth 12% compounded quarterly,
a) what was the cash price of the said property?
b) What was the amount of the down payment?

5) A P 25 million debt which includes interest is to be paid in three years by four equal end
of a quarter payments of P 2.25 million then by two equal end of a semi-annual
payments of P3.5 million and a final payment at the end of the period. If the said debt is
discounted at a rate of 10% ;
a) what was the amount of the final payment?
b) what was the actual amount of money granted to the debtor?
c) if the debtor wishes to pay all his debt after one year of payments, what was the
amount to be paid?