EECO 413

ENGINEERING ECONOMY
BATAAN PENINSULA STATE UNIVERSITY
College of Engineering & Architecture
Prof. RUEVAN E. ALBORO, MEM
Instructor

BACHELOR OF SCIENCE IN MECHANICAL ENGINEERING

4A = 11:30-1:30pm (Tuesday- ECE Lab), 1-2:00pm (Friday-205)
4E = 9:30-11am(Monday-PhysLec2), 1:30-3pm(Wednesday-PhysLec1)
•ANNUITY
• Though often associated with a specific
insurance-related product, an annuity is
any asset that generates regular payments
for a set time period. This type of
investment is often used by those
preparing for retirement or for a period of
planned unemployment. Depending on the
types of investments used, annuities may
generate either fixed or variable returns.
• Both the present and future
value calculations assume a
regular annuity with a fixed growth
rate. Many online calculators
determine both the present and future
value of an annuity, given the interest
rate, payment amount and duration.
• The present value of an annuity is simply the current value
of all the income generated by that investment in the future –
or, in more practical terms, the amount of money that would
need to be invested today to generate consistent income
down the road. Using the interest rate, desired payment
amount and number of payments, the present value
calculation discounts the value of future payments to
determine the contribution necessary to achieve and
maintain fixed payments for a set time period.

Present Value of an Annuity

• The future value of an annuity represents the amount of
money that will be accrued by making consistent
investments over a set period, assuming compound interest.
Rather than planning for a guaranteed amount of income in
the future by calculating how much must be invested now,
this formula estimates the growth of savings, given a fixed
rate of investment for a given amount of time.

Future Value of an Annuity

RECALL/ REVIEW
• I = Pin (2-01)
• F = P + I = P + Pin
•F = P+I (2-02)
• F = P (1 + in) (2-03)

Simple Interest
FOR SINGLE
PAYMENTS

FOR SINGLE
PAYMENTS
 (2-04)

Formula for
Compound Interest
• 1. Nominal rate of interest – specifies the rate of interest and a
number of interest periods in one year.

• i = __r__ (2-06)
m COMPOUNDING
PERIODS
Where:
• i = rate of interest per interest period
• r = nominal interest rate
• m = number of compounding periods per year

Rates of Interest
• 2) Effective rate of interest – is the actual or exact
rate of interest on the principal during one year.

• Effective rate = F₁ - 1 = (1 + i)ᶬ - 1 (2-07)

INTEREST PERIODS
PER YEAR
Rates of Interest
• A=F i

For uniform series

(annuities):
• A deferred annuity is a type of annuity contract that
delays income, installment or lump-sum payments until the
investor elects to receive them.
• - is one where the payment of the first amount is deferred a
certain number of periods after the first.

Deferred Annuity
• 2 main phases:
• the savings phase, which is when you invest money into
the account, and
• the income phase, which is when the plan is converted into
an annuity begins paying the account owner. A deferred
annuity can be variable or fixed.

Deferred Annuity
• A deferred annuity is a contract between an individual
and a life insurance company in which funds are
exchanged for a promise to provide a competitive interest
rate with a minimum interest rate guarantee. The contract
also guarantees the principal investment. Because
annuities are classified as non-qualified retirement
instruments, they receive a tax benefit in the form of tax
deferral on earnings. Earnings are taxed as ordinary
income upon withdrawal or annuitization.
• When funds are deposited with a life insurer, they are
credited to an accumulation account in the annuity
owner's name. The life insurer then credits the account
balance with a fixed interest rate. In most cases, the fixed
interest rate is guaranteed for one year to 10 years. When
that period expires, the insurer resets the interest rate,
typically for one-year periods. Most annuity contracts
include a minimum rate guarantee that ensures the
interest rate the account receives never falls below a
certain minimum, regardless of the economic climate at
the time.

How a Deferred Annuity

Works
• Jane is in her 30s and is in the top 30 percent tax bracket.
She wants to make sure that she has a steady stream of
income upon retirement. She invests in a life insurance
policy with an interest rate of 3% per year. She is able to
defer taxes on the interest her premium payments earn.
The annuity matures when Jane retires and she has
another source of income to ensure a comfortable
existence post-retirement.

Example of a Deferred
Annuity
•DEPRECIATION
• ORDINARY ANNUITY – is one where the equal payments are made
at the end of each payment period starting from the first period.

• DEFERRED ANNUITY – is one where the payment of the first

amount is deferred a certain number of periods after the first.

• ANNUITY DUE - is one where the payments are made at the start of
each period, beginning from the 1st period.

• PERPETUITY – is an annuity in which the payments continue

indefinitely.

TYPES OF ANNUITY
ORDINARY ANNUITY
•DEPRECIATION
• Depreciation means the decrease in the value of
physical properties or assets with the passage of
time and use. It is the non-cash method of
representing the reduction in value of a tangible
asset. Specifically, it is an accounting concept that
sets an annual deduction considering the factor of
time and use on an asset's value. An asset is
depreciable if it has a determinable useful life of
more than one year in business or something to
produce an income.

What Is Depreciation?
• If you use an asset for over a year, it often loses value. To offset the
asset’s declining value with its cost, you can depreciate the expense.
Depreciation reduces the value of an asset over time.
• Depreciation is an income tax deduction. By decreasing the value of
the asset, your overall taxable income lowers. As your taxable income
lowers, your tax liability decreases.
• To depreciate property, you do not claim the entire cost of the asset on
your tax return. Instead, you spread the cost out over several years.
• Depreciation is considered an expense in your accounting books. List
depreciation on the income statement. Depreciation is a noncash
expense, so it does not affect cash flow or the amount of cash you have
on hand.

What is depreciation?
• You can depreciate tangible, long-term property that you use for
business operations. The property must be a physical object that you
can see and touch. And, the property must last more than one year at
your business. Usually, you must own the property to depreciate it.
• Common assets you might depreciate include vehicles, furniture,
equipment, and buildings.
• You cannot depreciate some assets. You can’t depreciate land because
it does not wear out and lose value. You also cannot
depreciate inventory since you sell it for revenue. Usually, you cannot
depreciate leased property.

What can I depreciate?

• Take a depreciation deduction on your tax return by attaching Form
4562, Depreciation and Amortization, to your tax return.
• Different kinds of property can be depreciated for a certain number of
years. To find out how long you can depreciate assets, review the
IRS’s Publication 946, How to Depreciate Property.
• Here are some common time frames for depreciating property:
• Computers, office equipment, vehicles, and appliances: For five years
• Office furniture: For seven years
• Residential rental properties: For 27.5 years
• Commercial buildings and nonresidential property: For 39 years

How do I depreciate property?

• a. Adjusted Cost Basis is the asset's original cost basis used to compute
depreciation deductions adjusted by allowable increases or decreases.
• b. First Cost (FC) or Cost Basis is the unadjusted cost basis of an asset. It
is the initial cost of acquiring an asset.
• c. Book Value (BV) is the original cost basis of the property including any
adjustments, less all allowable depreciation deductions.
• d. Market Value (MV) is the amount paid to a willing seller by a willing
buyer of an asset.
• e. Salvage Value (SV) is the estimated value of a property at the end of a
property's life.
• f. Recovery Period is the number of years of an asset's recovery.
• g. Usual Life (n) is the anticipated period of a property's life.
•

Terminologies in Depreciation
• Step 1: Determine the asset cost from the accounts department.
• Step 2: Figure out what will be the residual value of the asset at the
time of its disposal.
• Step 3: Determine the useful life of the asset based on its physical
condition and other standards.
• Step 4: Finally, the formula for depreciation expense is derived by
initially deducting the residual value from the asset cost and then
dividing the result by the useful life of the asset as shown above.

#1 – Straight Line Method

• Straight-line depreciation is the easiest
method for depreciating property.
With this method, you spread the cost
evenly across the asset’s expected
lifespan.

Straight-line depreciation
Depreciation Expense using the
Straight Line Method
Depreciation Cost =
($200,000 – $20,000) / 3
• For example, you buy business equipment worth
$4,000. You expect the equipment to hold value for
four years.

• Using the straight-line method, spread the expense

out equally over the equipment’s lifespan. The
depreciation expense is $1,000 per year for four
years ($4,000 / 4 years = $1,000 per year)
Year Equipment is Used Expense

Year 1 $1,000

Year 2 $1,000

Year 3 $1,000

Year 4 $1,000

Total $4,000
• With accelerated depreciation, you can
expense items faster than the straight-line
method. You deduct a higher percentage
of the property’s total cost during the first
few years after purchasing. Then, take
smaller deductions in later years.

Accelerated depreciation
• For example, you buy a vehicle for your business for
$10,000. Using the accelerated method, you deduct
$4,000 in the first year. For every year after, the
amount you deduct becomes smaller.

Year Equipment is Used Expense

Year 1 $4,000

Year 2 $3,000

Year 3 $2,000

Year 4 $1,000

Total $10,000
• Use IRS documents to figure out deduction
amount using the accelerated method. Take a
look at the IRS’s Modified Accelerated Cost
Recovery System (MACRS). Also, check out
the percentage table guide in Publication 946,
Appendix A for the percentage you can deduct
each year.
• As a small business owner, you can deduct the total cost of an asset in
the same year you bought it with Section 179.
• You can use Section 179 for both new and used equipment. Section
179 is available for most types of assets, including general business
equipment and off-the-shelf software.
• To claim Section 179, you must use the property more than 50% of the
time during regular business operations.
• There are limits to Section 179:
• You can deduct up to $500,000 each year.
• You can spend up to $2,000,000 on depreciable property.

Section 179
• If you spend over $2,000,000, reduce your Section 179 deduction for
each extra dollar. In other words, if you spend more than $2,000,000,
you can’t deduct the full expense with Section 179.
• You also cannot use Section 179 to deduct more in one year than your
net taxable business income.
• Bonus depreciation and Section 179
• In some cases, you can use bonus depreciation if you spend more than
the Section 179 limit. Bonus depreciation is worth 50% of expenses
over the $2,000,000 limit for the 2016 tax year.
• So, if you spent $2,500,000 on assets, you went $500,000 over the
Section 179 spending limit. You can use bonus depreciation on the
extra $500,000. Depreciate 50% of the extra amount, or $250,000.
The percentage you can deduct with bonus depreciation
changes each year. The following amounts are the
percentages you can deduct in future tax years:

Year Deduction

2016 50%

2017 50%

2018 40%

2019 30%
2. Depreciation by
Declining Balance Method
• Declining Balance Method is sometimes called the Constant-
Percentage Method or the Matheson formula. The
assumption in this depreciation method is that the annual
cost of depreciation is the fixed percentage (1 - K) of the
Book Value (BV) at the beginning of the year. The formulas
for Declining Balance Method of Depreciation are:
• Annual Rate of Depreciation(K): SV = FC (1 - K)n
• Book Value = FC (1 - K)m
• Depreciation at mth year = FC (1 - K)m-1 (K)
• Total Depreciation = FC - SV
• Step 1: Determine the asset cost from the accounts department.
• Step 2: Determine the useful life of the asset based on its physical
condition and other standards.
• Step 3: Also, note down the accumulated depreciation. Use this to
compute the book value of an asset as shown below.
• Book value of asset =(Asset cost – Accumulated depreciation)
• Step 4: Now, the rate for depreciation is derived by reciprocal of the
useful life of the asset as shown below.
• Rate of depreciation = 1 / Useful Life of the Asset
• Step 5: Finally, the formula for depreciation expense is derived by
multiplying the rate of rate of depreciation by two and book value of
the asset as shown above.

#2 – Double Declining Balance

Method
3. Depreciation by
Sum of Years Digit Method (SOYD)
• Sum of the Years Digit Method is an accelerated depreciation
technique based on the assumption that tangible properties are
usually productive when they are new, and their use decreases
as they become old. The formulas for the Sum of the Years
Digit Method of Depreciation are:
• Sum of years = (n / 2) (n + 1)
• Annual depreciation at 1st year= (FC - SV) (n / Sum of years)
• Annual depreciation at 2nd year = (FC -SV) ((n-1) / Sum of
years)
• Book Value = FC - Total depreciation at the end of nth year
• Sinking Fund Method is a depreciation method wherein funds will
accumulate for replacement purposes. The formulas for Sinking Fund
Method of Depreciation are:
• Annual depreciation (A) = [ (FC -V) (i) ] / [ (1 + i)^(n) -1 ]
• Total depreciation after x years = A [(1 + i)^x - 1] / i
• Book Value = FC -Total depreciation

4. Depreciation by
Sinking Fund Method
• Working Hours Method also called as Service Output Method is a
depreciation method that results in the cost basis allocated equally over
the expected number of units produced during the period of tangible
properties. The formula for Working Hours Method of Depreciation is:
• Depreciation per hour = (FC - SV) / Total number of hours

5. Depreciation Using
Working Hours Method
• Constant Unit Method is the same with Working Hours
Method in the structure of the formula. The formula for
Constant Unit Method of Depreciation is:
• Depreciation per unit = (FC - SV) / Total number of units

6. Depreciation Using
Constant Unit Method
• Step 1: Determine the asset cost from the accounts department.
• Step 2: Figure out what will be the residual value of the asset at the
time of its disposal.
• Step 3: Determine the useful life of the asset in terms of units i.e. the
no. units that can be produced by the asset during the course its life.
Based on that, calculate the depreciation cost per unit as shown above.
• Per unit depreciation cost = (Asset Cost – Residual Value) / Useful
Life in Units of Production
• Step 4: Now, determine the units produced during the accounting
period.
• Step 5: Finally, the formula for depreciation expense is derived by
multiplying units produced during the period with the per unit
depreciation cost.

#2 – Unit of production method

 #2 – Unit of Production Method

Depreciation Cost in year 1

= ($200,000 – $20,000) / (1,500 + 1,200 + 900) * 1,500
= $75,000
Depreciation Cost in Year 2

Depreciation Cost in Year 2

Depreciation Cost in year 2 = ($200,000 –

$20,000) / (1,500 + 1,200 + 900) * 1,200
= $60,000
 Depreciation Cost in Year 3

Depreciation Cost in year 3 = ($200,000 –

$20,000) / (1,500 + 1,200 + 900) * 900
= $45,000
THANK YOU VERY MUCH!
ruevanealboro@yahoo.com