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Compounding

( ) Geometric Gradient series present worth


Discounting factor
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Uniform series compound amount factor [ ]
*occurs in same period
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Sinking Fund Factor ( )
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( ) Rule 72
Uniform series present worth factor
*separated by one period
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Capital recovery factor
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Arithmetic Gradient Series present worth
factor

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Created by: Joshua Eliah E. Marquez


Engineering Economy – collections of technique to compare alternatives on the basis of economics
Alternatives – other methods to solve the same problem
Cash Flow – the total amount of money being transferred into and out of a business
Present worth (P) – equivalent value of future expenses/earnings based on interest
Intangible Factors – Variable that are objective and cannot be equated to a monetary value
Principal (PO) – initial amount of money invested or borrowed in transactions
Interest (I) – Manifestation of the time value money; Borrower – Paying; Lender – Earning
Simple Interest – interest is earn only on the principal amount
Compound Interest – Interest earned is in on the principal and amount accumulated in previous interest periods
Rate of Return [a.k.a. Interest rate, Return on Investment] (i) – Interest expressed in percentage
Inflation – Loss of value of money over time
Minimum Attractive Rate of Return [hurdle rate] (MARR) – Criterion used to evaluate engineering alternatives,
should be higher than cost of money to finance alternative plus rate on safe investment
Market Interest Rates – reflects ROR plus Inflation rate
Interest period (n) – determines how frequently interest is calculated
Future amount of money (F) – results from the cumulative effects of money
Economic Equivalence – That different sum of money at different times would be equal in economic value
Compounding – procedure of finding future value of present amount based on interest rates
Discounting – procedure of finding present value of future amount based on discounting rates
The Rule of 72 – number of years it will take for a sum of money to double its amount
Annuities (A) – occur in consecutive interest periods with the same amount each period
Arithmetic Gradient – a uniform amount
Geometric Gradient – constant percentage

Notation
Compounding ( )
Example: “the F given the P for an interest rate of i for n interest periods”

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Created by: Joshua Eliah E. Marquez


Solutions
SINGLE PAYMENT FORMULAS
Problem 1: A business owner avails of a loan from a bank amounting to Php 500,000.00 to finance his expansion
project. The interest rate on the loan is set at 15% per annum. It is expected that he will be paying a total amount
of Php 1,529,511.43 at the end of the loan period. How many years are given to him by the bank to save up for the
loan payment?

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Problem 2: A geothermal exploration and production company loaned an amount of Php 15M at 15% per annum
to finance the drilling of three geothermal wells. The loan will be fully repaid after 10 years. Drilling of the three
wells was finished by the end of year 2. Commissioning of the wells took another year before the wells were
considered ready for production. The first revenue stream from the wells came at the end of year 4 which
amounted to Php 3M. If the company decided to use their entire first revenue for the repayment of the loan, how
much will the company be left to pay at the end of the 10-year loan period?

P
Solution:
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Present Value of 4 year revenue
Years
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3,000,000.00 F

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Future Value of difference of Present Value of loan and present value of 4 year revenue
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OR the Difference of future value of Present Value of Loan and 4 year Revenue
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Created by: Joshua Eliah E. Marquez


Problem 3: An 18-year old college freshman is already thinking of setting up a retirement fund in a high-risk equity
fund that yields 18% per year. He is planning to deposit Php 20,000.00 as his initial investment two years from
now. Then, he is also planning to add another Php 15,000.00 every five years thereafter to his retirement fund
until he turns 40. However, if he decides to set-up his retirement fund today instead and allot a large one-time
investment, how much money should he have now so that the value of his retirement fund in his original plan will
be equal to the value of his retirement fund to his new plan by the time he turns 65 years old?

Compute for first plan future value at 65 P Years


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15,000.0
Compute for present value of future value 20,000.0 0
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Problem 4: Two investment portfolios offer bonds to prospective clients in which one portfolio carries an interest
rate of 7% per annum and the other one offers an interest rate of 9% per annum. If one client decided to distribute
his Php 5M initial investment in these two funds, how much shall he allocate in these two funds so that by the end
of year 10, he will have equal sums of money in both investment products?

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A manufacturing company realized a total saving of 200,000.00 in the current financial year due to the cost saving
improvements that it instituted throughout its product line two years ago.

If the company opts to invest this savings in a financial instrument yielding 8% per year to finance future capital
projects, what will be the equivalent value of the investment after ten years?

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If the company established the cost-saving measures four year ago, find the equivalent value of the savings two
year ago. Consider an interest rate of 8% per annum.

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Created by: Joshua Eliah E. Marquez


Five years ago, a businessman loaned an amount of 5M from a bank at an interest rate of 12% per year.
However, it encountered financial difficulties two years ago that prompted the business owner to avail of
another loan amounting to 1M at the same interest rate. The bank required the owner to repay the entirety of
the two loans, together with all the accrued interests, ten years after the first loan was made. Fortunately,
present sales exceeded expectations, thus, allowing the businessman to allocate 10% of the company’s profit in
the current financial year to the repayment of his loans. If the business registered a profit of 50M in the current
financial year, how much will be left for the business owner to pay off at the end of the loan period?
Compound to present worth the loans
First loan ( )
Second loan ( )
Total present loan amount

Compounding new present value of loans


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UNIFORM SERIES FORMULAS

To save up on manpower expenses, a manufacturing firm intends to lay-off a quarter of its employees over a
period of ten years to give way for the machination of some of its processes. To purchase the required equipment,
the company needs to avail a 50M loan from a bank at an interest rate of 15% per annum. How much should be
the minimum annual payment of the company to ensure that the whole loan will be paid off within 20 years if the
first payment will be made a year after the loan was made?
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A sinking fund will be setup by a company to ensure that it will have enough funds to pay off its outstanding debts
ten years from now. What will be the future value of the fund ten years from now if the company pledges to invest
750,000.00 every year starting next year at an interest rate of 7% per annum? What is the value of the sinking fund
factor?
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Created by: Joshua Eliah E. Marquez


By the time his first daughter was born, a father decided to set up a trust fund which he can use to finance her
daughter’s college education when she will finally turn 18 years old. He projected that he will have to spend
200,000.00 each year for the four year college education of her daughter.
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Total amount needed on 17 year (to use uniform series present factor, P and A is separated by one period)
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If he intends to make a onetime investment on the trust fund how much should his lump sum investment be if
the fund yields an interest rate of 10% per annum?
Lump Sum at current year

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If he chooses to make annual investments for 10 years instead, starting from his daughter’s first birthday. How
much would his annual payments be? Use an interest of 10% per annum.
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Find value at 10 year
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Find annual Payments

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If he chooses to make annual investments for 15 years starting from the day his daughter was born, how much
should his annual payments be? Use an interest of 10% per annum.
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Find Value at 14 year
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Find annual Payments

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Arithmetic Gradient Problems

The maintenance cost of heavy construction equipment is estimated to be 250,000.00 a year after the equipment
was acquired, 300,000.00 after two years, 350,000 after three years, and increasing by 50,000.00 thereafter. At an
interest rate of 10% per year, what is the present worth of 10 years of maintenance cost?

Find Present value of uniform annual payments


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Find value of gradient series
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Total Present worth

Created by: Joshua Eliah E. Marquez


A company hopes to have enough funds 12 years from now to finance its first major expansion overseas. To make
this possible, the company is planning to invest 1M two years from now on a fund yielding an annual interest rate
of 10%. Then, it pledges to increase its investment by 200,000.00 every year thereafter until the 10th year. How
much money will the company have for the expansion of its business 12 years from now?
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Convert everything to Present worth at 1 year
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Future value at year 12


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Geometric Gradient Formula


The maintenance of a newly acquired hand tractor is projected to cost 25,000.00 after its first year of operation.
This cost is expected to increase by 3% every year thereafter. To cover for the 10 year maintenance cost of this
equipment, a fund is to be set up today, which earns an interest rate of 10%. How much should the fund be valued
today so that it can cover for the maintenance cost of the tractor for the next 10 years of its useful life?

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A housing loan, amounting to 500,000.00, was availed by a home buyer from a bank at an annual interest rate of
14% to finance the down payment for a two-bedroom condominium unit that he intends to buy near his place of
work. The bank is providing him an option of settling his loan by making equal annual payments for the next 15
years. However, he wants to finish off paying his loan at the soonest possible time due to the high interest rate
that the bank charges him. His plan is to make a substantially large payment of 100,000.00 one year from now so
that his annual payments thereafter will decrease by 1%. Do you think he will be able to settle his debt obligation
from the bank in less than 15 years?

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Created by: Joshua Eliah E. Marquez