ENGINEERING ECONOMY

WORKSHEET #4: NOMINAL AND EFFECTIVE INTEREST RATES

Name:
HERNANDEZ, ARVIN D.
CH040 – C11

For each of the following problems, (a) draw the cash flow diagram (as needed); (b) present clean and clear
manual solutions to the problem; (c) highlight the final answer (only the final answer as required by the problem)
by enclosing it within a box.

1. For an interest rate of 1% per quarter, determine the nominal interest rate per (a) semiannual period, (b)
year, (c) 2 years.

Given:
Interest rate = 1% per quarter

Required:
Nominal rate (r) per semiannual period, year, and 2 years.

Solution:

r =interest rate per time period × number of periods

r per 6 months=( 1 % ) × ( 2 )
r per 6 months=2 %

r per year =( 1 % ) × ( 4 )
r per year =4 %

r per 2 years=( 1 % ) × ( 8 )
r per 2 years=8 %

2. Pollution control equipment for a pulverized coal cyclone furnace is estimated to cost $190,000 two years
from now and an additional $120,000 four years from now. If Monongahela Power wants to set aside enough
money now to cover these future costs, how much must be invested at an interest rate of 8% per year,
compounded semiannually?

Given:
F at 2 years = $190,000
F at 4 years = $120,000
Interest rate of 8% per year, compounded semiannually

Required:
P

Page 1 of 5
 ENGINEERING ECONOMY

Solution:

Cash Flow Diagram

r = 8% per year,
comp quarterly Y 0 1 2 3 4
0 1 2 3 4 SP 0 1 2 3 4 5 6 7 8

$120,000 $120,000
$190,000 $190,000

P=? P=?

P= (190,000 ) ( PF , 4 % , 4 )+(120,000)( PF , 4 % , 8)
P= (190,000 )( 1+0.04 )−4 + ( 120,000 ) ( 1+0.04 )−8

P=$ 250,095.62

3. The optical products division of Panasonic is planning a $3.5 million building expansion for manufacturing its
powerful Lumix DMC digital zoom camera. If the company uses an interest rate of 16% per year, compounded
quarterly for all new investments, what is the uniform amount per quarter the company must make in order
to recover its investment in 3 years?

Given:
P = $3,500,000
Interest rate of 16% per year, compounded quarterly

Required:
P

Solution:

Cash Flow Diagram

r = 16% per year,

comp quarterly Y 0 1 2 3
0 1 2 3 Q 0 1 2 3 4 5 6 7 8 9 10 11 12

A=? A=?

$3.5M $3.5M Page 2 of 5

 ENGINEERING ECONOMY

PP=3 months
CP=3 months
4 1
effective i per quarter= 1+ ( ) 1
−1=4 % per quarter

A=( 3,500,000 ) ( AP , 4 % , 12)

(0.04)(1+0.04)12
A=(3,500,000)
[ (1+ 0.04)12−1 ]
A=$ 372,932.60 per quarter

4. Thermal Systems, a company that specializes in odor control for wastewater treatment plants, made deposits
of $100,000 now and $25,000 every 6 months for 2 years. Determine the future worth after 2 years of the
deposits for i = 16% per year, compounded quarterly.
Given:
P = $100,000
A every 6 months for 2 years = $25,000
Interest rate of 16% per year, compounded quarterly

Required:
F

Solution:

Cash Flow Diagram

r = 16% per year,

comp quarterly Y 0 1 2
0 1 2 Q 0 1 2 3 4 5 6 7 8

$25,000 $25,000
$100,000 $100,000

F=? F=?
PP=6 months
CP=3 months
0.08 2
effective i per 6 months= 1+ ( 2 ) −1=8.16 % per 6 months

F=( 100,000 ) ( FP , 8.16 % , 4)+( 25 , 000 ) ( FA , 8.16 % , 4)

Page 3 of 5
 ENGINEERING ECONOMY

(1+ 0.0816) 4−1

4
F=( 100,000 ) ( 1+ 0.0816 ) +(25,000)
[ ( 0.0816)4 ]
F=$ 249,776.34
5. How long will it take for a lump-sum investment to double in value at an interest rate of 1.5% per month,
compounded continuously?

Given:
Interest rate of 1.5% per month, compounded continuously

Required:
N

Solution:
i=e r −1
i=e (0.015 )−1
i=1.5113 %

2 P=P ( FP ,1.5113 % , N )
2 P=P(1+0.015113) N
2=(1+0.015113)N

N=46.2 months

6. How much money can a production company that makes fluidized bed scrubbers spend now instead of
spending $150,000 in year 5 if the interest rates are estimated to be 10% per year in years 1 to 3 and 12% per
year in years 4 and 5?

Given:
F = $150,000
Interest rate in years 1 to 3 = 10% per year
Interest rate in years 4 to 5 = 12% per year

Required:
P
Solution:

Cash Flow Diagram

12% 12%

10% 10% 10%

0 1 2 3 4 5
P= (150,000 ) ( PF , 12 % , 2)( PF , 10 % , 3) Page 4 of 5
−2 −3
P= (150,000 )( 1+0.12 ) ( 1+ 0.10 )
 ENGINEERING ECONOMY

$150,000
P=?

Page 5 of 5