ENGINEERING ECONOMICS

Engineering Economy – study of the cost factors involved in engineering projects, and using the
results of such study in employing the most efficient cost-saving techniques without affecting the
safety and soundness of the project.

INTEREST
Interest – money paid for the use of borrowed money.
Simple Interest – the interest paid on the principal only. In practice, simple interest is paid on
SHORT-TERM loans in which the time of the loan is measured in days. Also known as nominal rate
of interest.
(for exact simple interest)
(a) Ordinary Simple Interest February: 28/29
January: 31 July: 31
1 month = 30 days
February: 28/29 August: 31
1 year = 360 days
March: 31 September: 30
(b) Exact Simple Interest
April: 30 October: 31
365 days in ordinary year
May: 31 November: 30
366 days in leap year
June: 30 December:31
FORMULA:

I = Pin where: P = principal or present value

F=P+I I = interest
F = P(1 + in) F = future value
i = interest rate per period (if not specific, consider per year)
n = number of interest period

Compound Interest – the interest earned by the principal is not paid at the end of each interest
period, but is considered as added to the principal, and therefore will also earn interest for the
succeeding periods.

FORMULA:

F = P(1 + i)n

Rates of Interest:
(a) Nominal Rate of Interest where: i = rate of interest per interest period
r r = nominal rate of interest
i=
m m = number of compounding periods per year
(b) Effective rate of Interest
r m
i e =(1+ ) −1
m
 Methods of Compounding No. of Interest Periods in a Year (m)
Annually / Yearly 1
Semi – Annually 2
Quarterly 4
Bi – Monthly 6
Monthly 12
Daily 365

Continuous Compounding of Interest

FORMULA: where: F = future value

P = present value
F = Pern r = rate of compounding interest
n = number of interest period

Discount – difference between the future worth and its present worth.

FORMULA:

D=F–P where: D = discount

D d = discount rate for the period involved
d= =1−(1+i)−1 i = rate of interest for the same period
F
d
i=
1−d

SAMPLE:
1. If 1000 accumulates to 1340 when invested at a simple interest for two years, what is the
rate of interest?
(a) 17.12% (b) 17% (c) 16.81% (d) 17.37%
2. Determine the exact simple interest on 5050 invested for period from January 21, 1999 to
March 2, 2000, if the rate of interest is 18%.
(a) P1008.76 (b) P1008.34 (c) P1011.11 (d) P1010.68
3. Donald buys a VR console from a merchant who ask 1450 at the end of 60 days. Donald
wishes to pay immediately and the merchant offers to compute the cash price on the
assumption that money is worth 8% simple interest. What is the cash price?
(a) 1469.33 (b) 1496.33 (c) 1403.92 (d) 1430.92
4. $5,000 is borrowed 75 days at 16% per annum simple interest. How much will due at the
end of 75 days?
(a) 5,166.67 (b) 5,616.67 (c) 5,661.67 (d) 5,666.17
5. The amount of 20,000 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.
(a) 32,830.45 (b) 32,078.45 (c) 31,079.73 (d) 30,890.34
 6. Mr. Dela Cruz borrowed money from a bank. He receives from the bank P1340.00 and
promise to pay P1500.00 at the end of 9 months. Determine the corresponding discount
rate often referred to as the banker’s discount.
(a) 13.13% (b) 13.56% (c) 13.73% (d) 13.93%
7. An amount of 1000 becomes 1888.48 after 4 years compounded monthly. Find the nominal
interest.
(a) 15.75% (b) 16.44% (c) 14.76% (d) 16%
8. What nominal rate compounded bi-monthly yields the same amount as 12% compounded
quarterly?
(a) 11.94% (b) 11.49% (c) 12.94% (d) 12.49%
9. How many years will P100,000.00 earn a compound interest of P65,000 if the interest rate
is 10% compounded quarterly?
(a) 4.76 years (b) 5.07 years (c) 5.22 years (d) 6.05 years
10. A sum of 1000 is invested now and left for eight years at which time the principal is
withdrawn. The interest accrued is left for another eight years. If effective annual interest is
5.5%, what will be the withdrawal amount at the end of the 16th year?
(a) 820.58 (b) 805.28 (c) 825.08 (d) 852.08

CASH-FLOW DIAGRAM
A graphical representation of cash flows drawn on a time scale. In economic analysis
problems, it is analogous to that of free body diagram for mechanic problems.

∑↑ = ∑↓

SAMPLE:
1. A man bought a second-hand car worth P150,000 if paid in cash. However, in instalment
basis, he made a down payment of P50,000 and the balance were paid according to the
following: P30,000 at the end of 1st year, P40,000 at the end of 2nd year and a final
payment at the end of 5th year. Find the final payment if money is worth 12% per year.
(a) P72,831.47 (b) 78,231.47 (c) 78,321.47 (d) 78,213.47
2. Jane owes 25,000 due in 1 year and 75,000 due in 4 years. He agrees to pay 50,000 today
and balance in 2 years. How much must he pay at the end of two years if money worth 5%
compounded semi-annually
(a) 39,120.28 (b) 39,012.28 (c) 39,021.28 (d) 39,201.28
3. A couple borrowed P425,000 now from a lending company at 12% compounded quarterly
and agreed to pay the loan according to the following: pay P200,000 at the end of 2 years,
loan an additional of P75,000 at the 3rd year, pay P300,000 at the end of 4th year and X at
the end of 5th year. Find X.
(a) 239,800.21 (b) 242,259.59 (c) 266,205.25 (d) 238,222.21

ANNUITY
Annuity – a series of equal payments occurring at equal intervals of time.

Types of Annuity

1. Ordinary Annuity - payments are made at the end of equal period.

 A A A F

0 1 2 3 n

FORMULA:

where: F = future value

1−(1+i)−n
P= A [
i ] P = present value
n = number of periods
i = interest rate per period
(1+i)n−1 A = periodic payments
F= A [
i ]
2. Deferred Annuity – first payment is made several periods after the beginning of the
annuity.
A A A F

0 1 2 3 4 m 1 2 3 n

FORMULA:

1−(1+i)−n
P= A [ i ]
(1+i)−m

3. Perpetuity – payment are made indefinitely or forever.

FORMULA:
A
P=
i
4. Annuity Due – payment started at the beginning of annuity periods.
FORMULA:

1−(1+i)−(n−1) (1+i)(n+1) −1
P= A [ i
+1 ] F= A [ i
+1 ]
 5. Annuity with Continuous Compounding of Interest

FORMULA:

1−e− jn
P= A
[ e j −1 ] where: j = rate of interest compounded continuously

e jn −1
F= A
[ ] e j −1

SAMPLE:
1. A man bought a car in instalment basis. If he is paying P10,000 per month at a rate of 12%
compounded monthly for 3 years, find the cash price of the car.
(a) P301,075.05 (b) P310,075.05 (c) P301,750.05 (d) P310,750.05
2. Rainer Wandrew borrowed P50,000 from Social Security System, in the form of calamity
loan, with interest at 8% compounded quarterly payable in equal quarterly instalments for
10 years. Find the quarterly payments.
(a) P1827.79 (b) P1872.79 (c) 1877.79 (d) 1822.79
3. A man deposited a certain amount when his son was born, at a rate of 12% per annum,
with the intention that his son can withdraw P10,000 per year for 5 years starting on the
son’s 18th birthday. However, the trust company offer the son an option, that he may not
make withdrawals but he can withdraw the money as a single lump sum on his 25 th
birthday, and the son selected the option. Find the amount deposited by the man and the
amount withdrawn by the son.
(a) P5,250.15, P89,252.89 (c) P5,205.15, P89,252.89
(b) P5,205.15, P89,522.89 (d) P5,250.15, P89,522,89
4. Find the present worth of the annuity paying P5,000 per month at a rate of 12%
compounded quarterly forever.
(a) P505,050.50 (b) P505,550.50 (c) P550,050.50 (d) P505,500.50
5. How much should be deposited by the man at a rate of 12% per annum in order to pay the
following: P4,000 per year for the first five years, P6,000 per year on the next 6 years, and
P9,000 per year thereafter?
(a) P49, 977.35 (b) P49,797.35 (c) P47,997.35 (d) P49,779.35
6. Find the future worth of the annuity due paying P1,000 per month for 3 years at a rate of
12% compounded monthly.
(a) P43,507.65 (b) P43,057.65 (c) P43,075.65 (d) P43,705.65
7. Today, an entrepreneur borrowed money to be paid in 10 equal payments in 10 quarters.
If the interest rate is 10% compounded quarterly and the quarterly payment is $200, how
much did he borrow?
(a) $1,539.20 (b) $1,689.20 (c) $1,750.41 (d) $1,228.91
8. A man loan 187,400 from a bank with an interest at 5% compounded annually. He agrees
to pay his obligations by paying 8 equal annual payments. The first being due at the end of
ten years. Find the annual payments.
(a) 44,980.56 (b) 42,864.90 (c) 43,849.56 (d) 42,821.87
 9. A man paid 10% down payment of 200,000 for a house and lot and agreed to pay the 90%
balance on monthly instalment for 60 months at an interest rate of 15% compounded
monthly. Compute the monthly payment.
(a) 44,980.56 (b) 42,864.90 (c) 43,849.56 (d) 42,821.87
10. Maintenance cost of equipment is 20,000 for 2 years, 40,000 at the end of 4 years and
80,000 at the end of 8 years. Compute the semi-annual amount that will be set aside for
this equipment. Money is worth 10% compounded annually.
(a) 7108.43 (b) 7219.12 (c) 7312.78 (d) 7426.19
11. A farmer bought a tractor costing 25,000 payable in 10 semi-annual payments, each
instalment payable at the beginning of each period. If the rate of interest is 26%
compounded semi-annually, determine the amount of each instalment. (A)
(a) 4077.20 (b) 4607.24 (c) 3890.30 (d) 2248.49
12. To maintain a bridge, 5000 will be required at the end of 3 years and annually thereafter. If
the money worth 8%, determine the capitalized cost of all future maintenance. (B)
(a) 62,500 (b) 53,583.68 (c) 49,615.52 (d) 50,516.13

APPLICATION OF ANNUITY
1. Capitalized Cost – the sum of the first cost (FC) and the present worth of the following:
(a) Annual maintenance and operation cost (MC)
(b) Cost of repair (CR)
(c) Renewal Cost (RC)
where: k = interval of repair
FORMULA: L = useful life
RC = FC – CR – SV, if not given
MC CR RC SV = salvage value
CC =FC + + +
i k L
(1+i) −1 (1+i) −1

2. Bond Value – present worth or cost of a bond.

FORMULA: where: I = Fr, if not given
F = face value or par value
1−(i+1)−n r = bond rate per period
P=I [ i ]
+ C(1+i)−n i = yield of investment (rate of interest per period)
n = maturity period
C = F, if not given
C = redemption cost

3. Arithmetic Gradient – payments have common difference.

FORMULA:
P=P A + PG

1−(i+1)−n
P A =A [ i ] where: G = common difference

−n
G 1−(i+1)
PG =
i [ i
−n(1+i)−n ]
 F=F A + FG

(i+1)n−1
F A= A [ i ]
4. Geometric Gradient – payments have common ratio.

FORMULA:
A 1−w n 1+r
P=
1+i 1−w[ ; w=
1+i ] where: r = percent change

An
P= ; if i=r
1+r

SAMPLE:
1. A generator costs P60,000 and its salvage value is P10,000 after 10 years. Find the
capitalized cost if annual maintenance and operational costs is P4,000, cost of repair is P5,000
every two years and money is worth 12%.
(a) P134,356.48 (b) P143,356.48 (c) P134,653.48 (d) P143,653.48
2. How much are you going to pay for a bond whose par value is P10,000. Bond rate of 12%
compounded semi-annually and maturity period is 10 years, if the expected yield of investment
is 14% compounded semi-annually?
(a) P8,940.60 (b) P8,409.60 (c) P8,904.60 (d) P8,490.60
3. A bond with a par value of P1,000 will mature in 7 years with a bond rate of 8% payable
annually. It is to be redeemed at par at the end of this period. If it is sold at P1,050, determine
the yield at this price.
(a) 7.07% (b) 6.07% (c) 5.07% (d) 8.07%
4. Supposed a man receives an initial annual salary of P60,000 increasing at the rate of P5,000
a year. If money is worth 10%, determine his equivalent uniform annual salary for a period of
eight years.
(a) P75,022.40/yr (b) P75,220.40/yr (c) 75,202.40/yr (d) P75,002.40/yr
5. The capitalized cost of a piece of equipment was found to be 142,000. The rate of interest
used in computation was 12%, with a salvage value of 10,000 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.
(a) 89,678.45 (b) 98,673.67 (c) 88,687.42 (d) 67,854.32
6. Annual maintenance cost for a machine is 1500 this year and are estimated to increase 10%
each year every year. What is the present worth of the maintenance cost for six years if
interest is 8%?
(a) 8,728.80 (b) 8,782.80 (c) 8,788.80 (d) 8,722.80
7. The year-end operating and maintenance cost of a certain machine are estimated to be
12,000 the first year and to increase by 2,500 each year during its 4-year life. If capital is worth
12%, determine the equivalent year end cost.
(a) 15,397.13 (b) 15,456.98 (c)15,447.11 (d) 15,900.66
DEPRECIATION
Depreciation – the decrease in worth of a property due to passage of time.
Salvage Value – the worth of a property when sold as 2nd hand within its useful life.
Book Value – the worth of the property listed in the book of accounts of an enterprise.
Scrap Value / Junk Value – worth of a property when sold at the junk.

Methods of Calculation

1. Straight Line Method (SLM)

- Simplest method
- Depreciation charge is constant

FORMULA:

C O−C L
d=
L
n CO −C L
Dn=nd=
L L ( )
C n=C O−Dn
where: d = constant depreciation charge per year
2. Sinking Fund Method (SFM) dn = depreciation charge at the nth year
- Depreciation charge is constant Dn = total depreciation after n years
- Interest is included Cn = book value after n years
CO = original cost
FORMULA: CL = salvage value
(C ¿ ¿ O−C L )i L = useful life
d= ¿
(1+i)L −1

(1+i)n−1
Dn=d [ i ]
C n=C O−Dn

3. Sum of the Year’s Digit Method (SYDM)

- Depreciation charge varies from year to year

FORMULA:

2( L−n+1)
d n= (C ¿ ¿ O−C L )¿
L( L+1)
 n( 2 L−n+1)
D n= (C ¿ ¿ O−C L ) ¿
L(L+1)

C n=C O−Dn

4. Declining Balance Method (DBM)

- Constant percentage method
- Matheson’s formula

d n=CO k (1−k )(n−1)

where: k = constant percentage in the declining
book value
C n=C O (1−k)n
NOTE: DBM is not applicable if CL = 0
D n=C O [1−( 1−k )n ]

C L =C O (1−k) L

CL n Cn
k =1−
√
L

CO
=1−
√
CO

5. Double-Declining Balance Method (DDBM)

- Similar to DBM, simply replace k by 2/L

6. Service – Output Method

(a) Service Method – number of operating hours is the reference.

C O−C L
d n=H n ( H ) where: H = total operating hours within the useful life
Hn = number of operating hours at the nth year
(b) Output Method – number of units produced is the reference

d n=T n ( C −C
T
O
) L where: T = total number of units produced within the useful life
Tn = number of units produced at the nth year

SAMPLE:
1. A generator costs P60,000 and the salvage value is P10,000 after 10 years. If money worth
12% per annum, find:
(a) The depreciation by SLM, SFM.
(a) P6,000, P2,948.21 (b) P5,000, P2,948.21
(c) P6,000, P2849.21 (d) P5,000, P2,849.21
(b) The depreciation at the 4th year by SYDM, DBM, DDBM.
(a) P6363.64, P5947.29, P6414.00
(b) P6336.64, P5749.29, P6441.00
(c) P6363.64, P5749.29, P6144.00
(d) P6633.64, P5479.29, P6144.00
(c) The book value after 8 years by SLM, SFM, SYDM, DBM, DDBM.
(a) P20500, P24559.61, P12727.27, P14315,33, P10066.33
(b) P20000, P24955.61, P12727.27, P14315,33, P10066.33
 (c) P21000, P24559.61, P12772.27, P14315,33, P10066.33
(d) P21500, P24559.61, P12727.27, P14315,33, P10066.33
2. An asphalt and aggregated mixing plant having a capacity of 50 cu. m. every hour costs
P2,500,000. 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 P100,000, determine
(a) The total depreciation during the year
(a) P180,000 (b) P181,000 (c) P182,000 (d) P183,000
(b) The depreciation cost chargeable to each unit batch of 50 cu m.
(a) P3,500 (b) P3,600 (c) P3,700 (d) P3,800
3. The cost of equipment is P500,000 and the cost of installation is P30,000. If the salvage value
is 10% of the cost of equipment at the end of 5 years, determine the book value at the emnd of
the fourth year. Use straight line method.
(a) P155,000 (b) P140,000 (c) P146,000 (d) P132,600
4. A telephone company purchased a microwave radio equipment for P6M. Freight and
instalment charges amounted to 3% of the purchased price. If the equipment shall be
depreciated over a period of 8 years with a salvage value of 5%. Determine the depreciation
charge during the 5th year using the sum of the year’s digit method.
(a) P756,632.78 (b) P957,902.56 (c) P652,333.33 (d) P845,935.76
5. An equipment costs P480,000 and has a salvage value of 10% of its cost at the end of its
economic life of 35,000 operating hours. In the first year, it was used for 4,000 hours.
Determine its book value at the end of the first year.
(a) P430,629.00 (b) P380, 420.00 (c) P418,460.00 (d) P376,420.00

SUNK COST
Sunk Cost – cost which cannot be recovered due to certain reasons.

FORMULA:

SC = Cn – Trade-in Value(or resale value)

DEPLETION
Depletion – decrease in worth of a natural resource such as timber lands, oil and gas wells, etc.

SAMPLE:
1. A generator costs P60,000 4 years ago and the salvage value is P10,000 6 years from now. If
it is to be replaced by a new one and the resale value is P25,000, find the sunk cost if money
is worth 12%.
(a) P22,832.70 (b) 21,832.70 (c) P21,382.70 (d) P22,382.70
2. To develop an oil well containing 2,000,000 barrels of oil required and initial investment of
P30M. In certain years, 400,000 barrels of oil were produced from this well. Determine the
depletion charge during this year.
(a) P300,000 (b) P301,000 (c) P310,000 (d) P300,100

BREAK-EVEN ANALYSIS
 (a) Break-even Point (BEP) – it is a point ineconomic study where the sales volume or income is
just enough to pay the cost of production, hence, no profit.
FORMULA:

Sales = Fixed Cost + Variable Cost

Variable Costs: material costs, labor costs, and others

(b) Unhealthy Point (UHP) – it is a point in economic study where the sales volume is just
enough to pay the dividends.
FORMULA:

Sales = Fixed Cost + Variable Cost + Dividends

(c) Profit Calculation

FORMULA:

Sales = Fixed Cost + Variable Cost + Dividends + Profit

INFLATION
Inflation – decrease of money’s purchasing power due to increase in material cost and services
FORMULA:

F = P(1 + f)n
F = rate of inflation

SAMPLE:
1. A company manufacturing calculators has a fixed costs of P150,000 per month. If the variable
cost is P1,000 per unit and the average selling price is P2,500 per unit, find:
(a) The number of units needed to be produced per month at BEP.
(a) 50 (b) 100 (c) 150 (d) 200
(b) If the company pays P12 per share annually for 30,000 shares, find the number of units
needed to produce per month at unhealthy point.
(a) 120 (b) 130 (c) 140 (d) 150
2. XYZ Corporation manufactures book cases that it sells for P65.00 each. It costs XYZ P35,000
per year to operate its plant. This sum includes rent, depreciation charges on equipment and
salary payments. If the cost to produce one bookcase is P50.00, how many cases must be
sold each year for XYZ to avoid taking any loss?
(a) 2334 (b) 539 (c) 750 (d) 2233
3. A telephone switchboard 100 pair cable can be made up with either enamelled wire or tinned
wire. There will be 400 soldered connections. The cost of soldering a connection on the
enamelled wire will be P1.65, on the tinned wire, P1.15. A 100-pair cable made up with
enamelled wire costs P0.55 per lineal foot and those made up to tinned wire costs P0.76 per
lineal foot. Determine the length of cable run in ft so that the cost of each installation would be
the same.
(a) 1121.06 (b) 1001.25 (c) 864.92 (d) 952.38