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Problems of

Engineering
Economy
Prepared by:
Engr. Glenn Ortiz
LECTURE 2: Interest and the Time Value of Money

Elements of Transactions Involving Interest

1. Many types of transactions involve interest-e.g.,
borrowing money, investing money, or purchasing
machinery on credit-but certain elements are common
to all of these types of transactions:
2. The initial amount of money invested or borrowed in
transactions is called the principal (P).

3.The interest rate (i) measures the cost or price of money
and is expressed as a percentage per period of time. It is the
amount paid for the use of borrowed capital or it is the
money earned by an investment.
4. A period of time called the interest period
(n)determines how frequently interest is calculated. (Note
that, even though the length of time of an interest period can
vary, interest rates are frequently quoted in terms of an
annual percentage rate.
5. A specified length of time marks the duration of the
transaction and thereby establishes a certain number of
interest periods (N).

6. A plan for receipts or disbursements (A) that yields a
particular cash flow pattern over a specified length of time. (For
example, we might have a series of equal monthly payments that
repay a loan.)
7. A future amount of money (F) results from the cumulative
effects of the interest rate over a number of interest periods.
8. Problems involving the time value of money can be conveniently
represented in graphic form with a cash flow diagram. Cash flow
diagrams represent time by a horizontal line marked off with the
number of interest periods specified. Arrows represent the cash
flows over time at relevant periods:
9. Upward arrows represent positive flows (receipts), and
downward arrows represent negative flows (disbursements).

Types of Interest
Simple interest- the type of interest that follows the
principle only the principal earned interest.
Simple Interest
I = Pin
Future worth or accumulated amount
F= P + I
F = P (1 + in)
where:
i= interest rate in decimal
n= number of years

Types of Simple Interest
Ordinary simple interest is computed based on 1
banker year = 360 days
Exact simple interest- is computed based on exact
number of days in one year as follows:
1 ordinary year (not divisible by 4) = 365 days
1 leap year (divisible by 4) = 366 days
1 century years = 100 years
If the century year is divisible by 400 it is a leap year,
otherwise it is an ordinary year

If the kind of simple interest is not mentioned in the
problem, assume it is an ordinary simple interest.
If exact simple interest, 30 days has September, April,
June and November. February has 28 or 29 days, the rest
31 days.
Compound Interest is type of interest that follows the
principle interest on top of an interest i.e. both
principal and interest earn interest.

Continuous Compounding assumes that compounding
continuously,
Nominal rate of interest (r) is the interest rate where
conversion is allowed.

Number of Compounding (m) is the number of
payments in one year.

Effective rate of interest (e) is the actual rate of interest
in one year. It is the interest rate for any compounding that
will give the same accumulation as computed compounded
annually.

Problem #1:

If P1000 accumulates to P1500
when invested at a simple interest
for three years, what is the rate of
interest?

Problem #2:
A loan of P5000 is made for a
period of 15 months, at a simple
interest rate of 15%, what future
amount is due at the end of the
loan period?

Problem #3:
If you borrowed money from your
friend with simple interest of 12%,
find the present worth of P50000,
which is due at the end of 7
months.

Problem #4:
Mr. J. Reyes borrowed money from
the bank. He received from the
bank P1842 and promised to repay
P2000 at the end of 10 months.
Determine the rate of simple
interest.

Problem #5:
A man borrowed money from a
loan shark. He receives from the
loan sharkand amount of P1342.00
and promised to repay P1500.00 at
the end of 3 quarters. What is the
simple interest rate?

Problem #6:
Determine the exact simple interest
on P5000 invested for the period
from January 15,1996 to October
12,1996, if the rate of interest is
18%.

Problem #7:

The exact simple interest of P5000
invested from June 21,1995 to
december 25,1995 is P100. What is
the rate of interest?

Problem #8:

Nicole has P20,400 in cash. She
invested it at 7% from March 1,2006
to November 1,2006 at 7% interest.
How much is the interest using the
Bankers rule(360 days)?

Problem #9:
The amount of P20000 was
deposited in a bank earning an
interest 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.

Problem #10:

A loan for P50,000 is to be paid in 3
years at the amount of P65,000.
What is the effective rate of
money?

Problem #11:

Find the present worth of a future
payment of P80,000 to be made in
six years with an interest of 12%
compounded annually.

Problem #12:

What is the effective rate
corresponding to 18% compounded
daily? Take 1 year is equal to 360
days.

Problem #13:

What nominal rate, compounded
semi annually, yields the same
amount as 16% compounded
quarterly?

Problem #14:

What rate of interest compounded
annully is the same as the rate of
interest of 8% compounded
quarterly?

Problem #15:
Find the compound amount if
P2500 is invested at 8%
compounded quarterly for 5years
and 6 months.

Problem #16:
P100,000 earn a compound interest
of P50,000 if the interest rate is 9%
compounded quarterly?

Problem #17:

Compute the equivalent rate of 6%
compounded semi-annually to a
rate compounded quarterly.

Problem #18:
P20,0000 was deposited on January
1,1988 at an interest rate of 24%
compounded semi annually. How
much would the sum be on January
1,1993?

Problem #19:

What is the present worth P100
payments at the end of the third
year and fourth year? The annual
interest rate is 8%.

Problem #20:
A firm borrows P2000 for 6 years at
8% . At the end of 6 years, it renews
the loan for the amount due plus
P2000 more for 2 years at 8%.What
is the total future worth? What is
the lump sum due?

Problem #21:
Find the present value of installment
payments of P1,000 now, P2,000 at the
end of the first year, P3,000 at the end
of the second year, P4,000 at the end of
the third year and P5,000 at the end of
the fourth year, if money is worth 10%
compounded annually.
Problem #22:
If money is worth 5%
compounded quarterly, find the
equated time for paying a loan
of P 150,000 due in 1 year and
P280,000 due in 2 years.
Problem #23: