ANNUITIES AND

CAPITALIZED COST
GE301: ENGINEERING ECONOMY
ANNUITY
• A series of equal payments made at equal intervals of time
• Annuities occur in the following instances:
• Payment of a debt by series of equal payments at equal intervals of time
• Accumulation of a certain ammount by settling equal amounts
periodically
• Substitution of a series of equal amounts periodicall in lieu of a lump
sum at retirement of an individual

Types of Annuities
Ordinary Annuity
Is on where the equal payments are made at the end of each payment
period starting from the first period.
Deferred Annuity
Payment of the first amount is deferred a certain number of periods
after the first
Annuity Due
Payments are made at the start of each period, beginning from the
first period
Perpetuity
The payment periods extend forever or in which the periodic
payments continue indefinitely
ORDINARY ANNUITY
(P/A, i%, N) (F/A, i%, N)

Payment Periods
0 1 2 3 n-1 n
A

•  Let A = amount of each payment of an ordinary annuity

P = present value of the n ₱A payments
F = future worth or accumulated amount of the n ₱A
payments

Then
P = A(P/A,i%,n) = ]
F = A(F/A,i%,n) = ]
DEFERRED ANNUITY

k|(P/A, i%, N) (P/A, i%, N)

0 1 2 3 k k+1 k+2 k+n

A B 0 1 2 n-1 n
C
Deferment, k periods Ordinary annuity, n periods

Deferred annuity, (k+n) periods

• If each payment is ₱A, then the present value of the deferred

annuity is
k|P = A(P/A, i%, N) (P/F, i%, k)
ANNUITY DUE

(P/A, i%, N)
(F/A, i%, N)

-1
A 0 1 2 n-1 n B

Annuity due, n periods

(n+1) periods

• If each payment is ₱A, then the present value of the deferred

annuity is
P = A(P/A, i%, n) = A[ 1 + (P/A, i%, n-1)]
F = A(F/A, i%, n) = A[ (F/A, i%, n+1) - 1]
PERPETUITY

(P/A, i%, )

A 0 1 2 n-1 n

Perpetuity, n = 

•  If each payment is ₱A, then the present value for a perpetuity
P = (P/A, i%, ) =
P=
Sample Problems
• Example 1.
Determine the value of each of the following annuity factors
(a) (P/A, 4%, 8) (c) (F/A, 9.8%, 21)
(b) (A/P, 14.5%, 10) (d) (A/F, 6.3%, 15)
• Example 2.
A steam boiler is purchased on the basis of guaranteed performance.
However, initial tests indicate that the operating cost will be P400 more per
year than guaranteed. If the expected life is 25 years and money is worth
10%, what deduction from the purchase price would compensate the buyer
for the additional operating cost?

• Example 3.
A farmer bought a farm and he paid P10,000 cash and agreed to pay P2,000 at
the end of each 6 months for 5 years. He failed to pay the first 5 payments. At
the end of 3 years, he is required to pay the seller the entire debt consisting of
his accumulated and future liabilities, otherwise the farm would be for closed
by the seller. What must he pay if money is worth 12% compounded semi-
annually?
Sample Problems
• Example 4.
How much money would you have to deposit for five consecutive years
starting one year from now if you want to be able to withdraw P50,000
ten years from now? Assume the interest is 14% compounded annually.

• Example 5.
A corporation will make the following reimbursements:
P50,000 on Dec. 31, 1991
P100, 000 on Dec 31, 1992
P200,000 on Dec 31, 1993
To accumulate these sums, a sinking fund is established by making equal
year-end deposits starting Dec. 31, 1986 up to end of 1993. If the fund earns
9% interest compounded annually, what is the required amount of the
annual deposit?

• Example 6.
A man invests P10,000 now for the college education for his 2-
year old son. If the fund earns 14% effective, how much will the
son get each year starting from his 18th to the 22nd birthday?
Sample Problems
• Example 7.
A person buys a piece of property for P100,000 down payment and ten
deferred semi-annual payments of P8,000 each starting three years from now.
What is the present value of the investment if the rate of interest is 12%
compounded semi-annually?
• Example 8.
A farmer bought a tractor costing P25,000 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.
• Example 9.
A man invests P10,000 now for the college education for his 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 P200,000
each year for 5 years, each payment being made at the beginning of each
year. The second bidder offered to pay P120,000 the first year, P180,000
the second year, and P270,000 each year for the 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.
CAPITALIZED COST
•• The
  capitalized cost of any structure or property (equipment, machinery,
building, etc.) is the sum of its first cost and the present worth of all
costs for replacement, operation, and maintenance for a long time or
forever

Capitalized cost = First Cost + Cost of Perpetual Maintenance

= FC +
Capitalized Cost =
Where:
S = the amount needed to replace or maintain the property every k
periods
CONTINUOUS COMPOUNDING FOR DISCRETE
PAYMENTS
  r e =1+i
i = 1 – er
(P/A, r%, n) = =

(F/A, r%, n) =
Sample Problems
• Example 10.
If the money is worth 8% compounded quarterly, compare the
present values of the following:
a) An annuity of P1,000 payable quarterly for 50 years;
b) An annuity of P1,000 payable quarterly for 100 years;
c) A perpetuity of P1,000 payable quarterly.
• Example 11.
It costs P50,000 at the end of each year to maintain a section of
Kennon road in Bagiuo City. If money is worth 10%, how much
would pay to spend immediately to reduce the annual cost to
P10,000?

• Example 12.
To maintain a bridge, P5000 will be required at the end of 3
years and annually thereafter, If money is worth 8%, determine
the capitalized cost of all future maintenance.
Sample Problems
• Example 13.
The capitalized cost of a piece of equipment was found to be
P142,000. the rate of interest used in the computations was
12%, with salvage value of P10,000 at the end of a service life of
8 years. Assuming that the cost of perpetual replacement
remains constant, determine the original cost of the equipment.
• Example 14.
Compare the capitalized costs of the following road pavements:
An asphalt pavement costing P100,000 which would last for 5 years with
negligible repairs. At the end of 5 years, P5,000 would be spent to
remove the old surface before P100,000 is spent again for a new surface.
A thick concrete pavement costing P250,000 which would last
indefinitely, with a cost of P20,000 for minor repairs at the end of every
3 years. Money is worth 8% compounded annually.