Engineering Economy

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.
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
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 define 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
Cash-Flow Diagrams
Cash-Flow Diagram – is a graphical representation of cash flows drawn

on a time scale.
↑ - receipt (positive cash flow or cash inflow)

↓ - disbursement (negative cash flow or cash outflow)
Cash-Flow Diagrams
Example: A loan of P100 at simple interest will become P150 after 5
years.
Cash flow diagram on the Cash flow diagram on the

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

The interest is computed on the basis of one banker’s year
(1 banker’s year = 360 days)
𝑫
I = Pr
𝟑𝟔𝟎
Simple Interest
Exact simple interest

The interest is based on the exact number of days in a year
(ordinary year = 365 days, leap year = 366 days)
𝑫
I = Pr
𝟑𝟔𝟓
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
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
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
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
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
Simple Interest
Example 6:
If you borrow money from your friend with simple interest of
12%, find the present worth of P 20,000 at the end of 9
months.
Ans. P 18,348.60
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.
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%
Compound Interest Future Worth, F:
F = P(1+i)n
The interest earned is
computed every end of each Where:
interest period (compounding
period) and the interest earned i = effective interest per interest
for that period is added to the period
principal.
nominal interest rate
i=
number of compounding per year
n = total number of compounding

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
Compound Interest
Single Payment Compound Amount Factor, F/P:
Fൗ = 1 + i n = FൗP , i%, n
P
Single Payment Present Worth Factor, P/F:
Pൗ = 1 + i −n = PൗF , i%, n
F
Compound Interest
Effective Rate of Interest, ER:
interest earned in one year F−P

ER = = = (1+i )n - 1
principal during that year P
Equivalent Rates:
ER1 = ER2
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
Compound Interest
Example 2:
A man expects to receive P 25,000 in 8 years. How much is
that money worth now considering interest at 8%
compounded quarterly?
Ans. P 13,265.83
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
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
Compound Interest
Example 5:
If money is worth 5% compounded quarterly, find 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
Compound Interest
Example 6:
How long will it take money to double itself if invested at 5%
compounded annually?
Ans. 14.2 years
Compound Interest
Example 7:
Compute the equivalent rate of 6% compounded semi-
annually to a rate compounded quarterly.
Ans. 5.96% ≈ 6% compounded quarterly
Compound Interest
Example 8:
If P5, 000.00 shall accumulate for 10 years 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.
Continuous Compounding Interest
F = Pert
where: ert is continuous compounded amount factor

r = nominal rate of interest
t = number of years
Effective rate if compounded continuously, ER:

ER = er - 1
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
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%
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
Example 4:
If the effective annual interest rate is 4%, compute the
equivalent nominal interest compounded continuously.
Ans. 3.922%
Example 5:
What is the nominal rate of interest compounded
continuously for 10 years if the compound amount factor is
1.34986?
Ans. 3%
Example 6:
Deposits of P35,000.00, P48,000.00 and P25,000.00 were
made in a savings account eight years, five years, and two
years ago, respectively. Determine the accumulate amount in
the account today if a withdrawal of P55,000.00 was made
four years ago. The applied interest rate is 11% compounded
continuously.
Ans. P 113,330.66
Discount
It is the difference between the
future worth of a certain commodity
and its present worth.
2 Types of Discount:
• Trade Discount – discount 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.
Discount
Discount Rate – is the discount on

D=F–P
one unit of principal per unit of
time.
where:
D = amount of discount 𝐅−𝐏 −𝟏
𝐝= =𝟏− 𝟏+𝐢
F = accumulated amount or 𝐅
future worth
Discount The relationship between discount
rate and interest rate becomes:
𝐝
If the commodity is discounted 𝐢=
𝟏−𝐝
in a certain period of time: and
𝐢
𝐝=
Fd = F − P 𝟏+𝐢
P = F 1 − d For 1 year where:
d = discount rate for the period
𝐏 = 𝐅 𝟏 − 𝐧𝐝 For n years involved
i = rate of interest for the same
period
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%
Discount
Example 2:
Find the discount if P 2,000 is discounted for 6 months at 8%
simple discount.
Ans. P 80
Inflation In an inflationary economy, the
It is the increase in the buying power of money decreases as
prices for goods and services from cost increases:
one year to another, thus decreasing 𝐏
𝐅=
the purchasing power of money. 𝟏+𝐟 𝐧
If interest is computed as the same
𝐅𝐂 = 𝐏𝐂 𝟏 + 𝐟 𝐧 time that inflation is occurring:
𝐧
𝟏+𝐢
𝐅=𝐏
where: 𝟏+𝐟
where:
FC = future cost of a commodity
F = future worth of today’s present
PC = present cost of a commodity amount P
f = annual inflation rate f = annual inflation rate
n = number of years n = number of years
i = rate of interest
Inflation
If the uninflated present worth is to be determined:
𝐅 𝐅
𝐏= 𝐧 𝐧
= 𝐧
𝟏+𝐢 𝟏+𝐟 𝟏 + 𝐢𝐜𝐟
𝐢𝐜𝐟 = 𝐢 + 𝐟 + 𝐢𝐟
where:
f = annual inflation rate
i = rate of interest
𝐢𝐜𝐟 = rate of interest that can take care of the cost of money and
inflation
Inflation
Example 1:
A man invested P 130,000 at an interest rate of 10%
compounded annually. What will be the final 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
Inflation
Example 2:
What is the uninflated present worth of a P 200,000 future
value in two years if the average inflation rate is 6% and
interest rate is 10%.
Ans. P 147,107
Plates
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 inflation 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 inflation 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 first 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
The functional symbol P/A, i%, n is called the “uniform series
present worth factor”.
Pൗ = 1+i n−1 Pൗ , i%, n

A = A
i 1+i n
The functional symbol A/P, i%, n is called the “capital recovery

factor”.
i 1 + i n
Aൗ = = Aൗ , i%, n
P 1+i n−1 P
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
Substituting P = F 1 + i from the equation of P, it becomes:
−n
A
F= 1+i n−1
i
Ordinary Annuity
The functional symbol F/A, i%, n is called the “uniform series

compound amount factor”.
1 + i n−1
Fൗ = = Fൗ , i%, n
A i A
The functional symbol A/F, i%, n is called the “sinking fund

factor”.
Aൗ = i Aൗ , i%, n
F = F
1+i n−1
Ordinary Annuity
Where:
F = value or sum of money at some future time

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 efficient, the company has
offered a superior a yearly gratuity pay of P 20,000.00 for 10 years
with the first 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:

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, find the
present amount of an annuity due paying P 5,000
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
first 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 first 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 – a type of annuity where the first payment is
made several periods after the beginning of annuity.
𝐀 𝟏+𝐢 𝐧−𝟏 −𝐦
𝐏= 𝐧
𝟏+𝐢
𝐢 𝟏+𝐢
Deferred Annuity
A 1+i n−1 −m
P= n
1+i
i 1+i
Where:
m = number of interest periods when there is no payment made
Deferred Annuity
A. Present Worth
[ 1+i 5 −1]
P1 =
(1+i)5i
P1
P= 3
1+i
Deferred Annuity
B. Future Worth
A[ 1+i 6 −1]
F=
1+i 6i
F2 = F(1 + i)4
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 18th, 19th , 20th 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
installment plan, a purchaser should pay P 20,000 downpayment
and 10 quarterly installments, the first due at the end of the first
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
For an annuity compounded continuously, replace interest rate with the

effective rate for compounded continuously. Recall that:
ER = er − 1
Replacing the interest rate for the formula of ordinary annuity with ER,
the formula becomes:
𝐀 𝐞𝐫𝐧 − 𝟏
𝐏= 𝐫
𝐞 −𝟏 𝐞𝐫𝐧
𝐀
𝐅= 𝐫 𝐞𝐫𝐧 − 𝟏
𝐞 −𝟏
𝐀 𝐞𝐫𝐧 −𝟏 𝐀
𝐏= and 𝐅= 𝐞𝐫𝐧 − 𝟏
𝐞𝐫 −𝟏 𝐞𝐫𝐧 𝐞𝐫 −𝟏
Where:
P = Present Worth
F = Future Worth
r = nominal rate of interest
n = number of years
Compound amount factor,

ern −1
CAF = r
e −1
Sinking Fund Factor,
er −1
SFF =
ern −1
Present Worth Factor,
1− e−rn
PWF = r
e −1
Capital recovery factor,
er −1
CRF =
1 − e−rn
Annuities
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
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 first 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%
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 flow above is equal to the

sum of the two cash flows shown.
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 flow may be analyzed using
this formulas:
Annuities
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
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:
BVm = book value of a property at any time m
Dm = total depreciation of a property at any time m
DL = total depreciation at the end of its useful life
FC = first cost
SV = salvage or scrap value
Depreciation
Straight Line Method Where:
Straight Line Method –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
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
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 first 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
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
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?
(c) At what year will its total depreciation be P30M?
Ans. P 101M; P 51M; 15th year
Plates
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 sinking
fund established in which funds
will accumulate for replacement. Where:
d = depreciation at any year
Dm = total depreciation of a property
The total depreciation that has at any time m
been taken place up to any given DL = total depreciation at the end of
time is assumed to be equal to its useful life
the accumulated amount in the L = useful life in years
sinking fund at any time. FC = first cost
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 first 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 five 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 depreciation dm = depreciation at any time m
is a fixed percentage (k) of the BVm = book value of a property at
salvage value at the beginning any time m
of the year. Dm = total depreciation of a
property at any time m
Note: This method is not FC = first cost
applicable if there is no
salvage value. SV = salvage or scrap 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?
(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
Example 2:
An equipment has a first 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
Example 3:
A machine having a certain first cost has a life of 10 years and
a salvage value of 6.633% of the first 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 first 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
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
1. A radio service panel truck initially costs P 56,000. If resale value
at the end of the fifth 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 first 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 at
Method – a method which is 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 first 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
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 first 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
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
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
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
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 4th 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
FC = first cost
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
Example 2:
The first 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
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
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
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
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 the Dm = total depreciation of a
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
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
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 first 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 first 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
Modified Accelerated Cost Recovery System, MACRS
Assumption: A shift from SL to DDM
d1 = (
1 2
2 n
FC – 0)
d2 = (
2
n
FC – d1 )
d3 =
2
n
( )
FC – d1- d1
Depreciation
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
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 3rd year using Modified 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
Payout Period
Fixed Capital
=
Annual profit+Annual depreciation
EXAMPLES
Example 1:
A broadcasting corporation was formed duly approved by the
Securities and Exchange office has a working capital of P 20 M and a
fixed capital of P 80 M. Annual depreciation amounts to P 5 M and
expected annual profit is P 16 M. Determine the recovery period in
years.
Ans. P 6.25 M
EXAMPLES
Example 2:
A fixed 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 fixed capital investment. Which
of the following gives the payout period in years?
Ans. 2.86
EXAMPLES
Example 3:
A fixed 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 fixed capital investment. If the
annual profit 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 fixed 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 fixed 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%
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

Engineering Economy

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Engineering Economy

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Engineering Economy

Blank, L T., (2012), Engineering Economy (7th Edition), New York:

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

5. Evaluate each alternative; consider noneconomic factors; use

Cash-Flow Diagram – is a graphical representation of cash flows drawn

↑ - receipt (positive cash flow or cash inflow)

Cash flow diagram on the Cash flow diagram on the

Ordinary simple interest

Exact simple interest

n = total number of compounding

a. compounded annually d. compounded monthly

Single Payment Compound Amount Factor, F/P:

Single Payment Present Worth Factor, P/F:

Effective Rate of Interest, ER:

interest earned in one year F−P

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

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

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

where: ert is continuous compounded amount factor

Effective rate if compounded continuously, ER:

Discount Rate – is the discount on

If the uninflated present worth is to be determined:

Continuous Compounding for Discrete Payments

Pൗ = 1+i n−1 Pൗ , i%, n

The functional symbol A/P, i%, n is called the “capital recovery

P = value or sum of money at present

The functional symbol F/A, i%, n is called the “uniform series

The functional symbol A/F, i%, n is called the “sinking fund

F = value or sum of money at some future time

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

P = value or sum of money at present

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

For an annuity compounded continuously, replace interest rate with the

Compound amount factor,

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

The cash flow above is equal to the

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

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

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

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