TOPIC NO.

2 REVIEW OF ENGINEERING ECONOMY

(PROBLEM-SOLVING) PART 1

SIMPLE INTEREST
Interest – is the money paid for the use of barrowed capital.
Simple interest – is the interest to be paid which is proportional to the length of time principal is
used
Formulas:
1. I = Pin

2. F = P + I

3. F = P(1 + in)

where: I = interest P = principal F = future amount n = no. of

years I = rate of interest per year
Note:
For Ordinary interest: 1 yr = 360 days
For Exact interest: 1 yr = 365 days
For leap year (exact interest) 1 yr = 366 days
Actual number of days per month:
January = 31 February = 29 (if not leap year) = 29 (for leap year)
March = 31 April = 30 May = 31 June = 30
July = 31 August = 31 September = 30 October =31
November = 30 December = 31

DISCOUNT
Discount – is the difference between the future worth and the principal amount.

O−A
1. Discount = O – A 2. Discount Rate =
O

where: O = original amount A = actual amount after the discount

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PROBLEMS
1. (ME Bd. Oct. 98) Determine the exact simple interest on P5,500.00 for the period from
January 10, 1996 to October 28, 1996 at 11% interest.

2. Cleofatra barrowed P2,000.00 from a bank and agreed to pay the loan at the end of one
year. The bank discounted the loan and give P1950 in cash. Determine the rate of discount.
A. 3.75% B. 3.12% C. 2.5% D. 1.2%

COMPOUND INTEREST
Is the interest earned by the principal which is added to the principal will also earned interest for
the succeeding period.
Cash Flow diagram – a graphical presentation of cash flow drawn on a time scale
Formulas:

1. F = P(1+i)n

F
2. P =
(1+i)n

n F
3. i = √ -1
P

In t
4. n =
In (1+i)

n
5. No. of years =
m

Where: t = F/P
n = number of periods = (no. of years) (m)
i = interest rate per period = in/m

5. Compound Interest = amount earned = F – P

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 6. (1+ i)n = single payment compound amount factor

7. (1 + i)-n = single payment present worth factor

Where: F = future amount

P = principal or capital
in = nominal interest rate
m = no. of periods per year
m =1 (annually) m = 2 (semi-annual) m = 4 (quarterly)
m =6 (bi - monthly) m =12 (monthly) m = 365 (daily)

Nominal and Effective Rate of Interest

1. in = effective interest rate
in m
in =(1+i)m -1= (1+ ) -1
m
2. ie annual = ie semi – annual = ie quarterly = ie bi – monthly = ie monthly = ie daily

Continuous Compounding
That is if m approaches infinity (m → ∞)
1. Future Worth: F = Pein
2. Present Worth: P = Fe-in
where: e = 2.718

3. Effective Interest rate, ie ie = ein -1

DECREASING VALUE
F = P(1 – i)n

BREAK EVEN ANALYSIS

A. To Break Even,

Total Income = Total Expenses

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 B. Expenses = Variable cost + Fixed cost

C. Profit = Income – (Variable cost + Fixed cost)

D. Loss = (Variable cost + Fixed cost) – Income

COMPOUND INTEREST PROBLEMS

1. Determine the accumulated value of P2000.00 in 5 years if it is invested at 115
compounded quarterly.
A. P3,4400.00 B. P3,404.00 C. P3,044.00 D. P4,304.00

2. You deposit $1800 into a 9% account today. At the end of two years, you will deposit
another $3000. In five years, you plan a $4000 purchase. How much is left in account one
year after the purchase?

3. A firm barrows $2500 for 6 yr at 8%, to be repaid in a lump sum at the end of 6 yr. At the
end of 3 yr, the firm renews the loan for the amount due plus $2500 more for 2 yr at 8%.
What is most nearly the amount of the loan renewal?

4. A company invests $13,000 today to be repaid in 5 yr in one lump sum at 11%

compounded annually. If the rate of inflation is 4% compounded annually, approximately
how much profit, in present day dollars, is realized over the 5 yr?

5. Michael owes P25,000 due in 1 year and P75,000 due in 4 years. He agrees to pay
P50,000 today and the balance in 2 years. How much must he pay at the end of two years
if money is worth 5% compounded semi – annually?

6. Consider a deposit of $6000, to be repaid back in 1 yr by $750. What are the conditions on
the rate of interest, I, in %/yr. compounded annually, such that the net present worth of the
investment is positive? Assume I ≥ 0 %.
A. 12. 5% ≤ i ≤ 14.3% B. 0% ≤ i ≤ 14.3% C. 0% ≤ i ≤ 25% D. 25% ≤ i ≤ 100%

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EFFECTIVE INTEREST
1. What is the effective rate equivalent of 16% compounded quarterly?
A. 12.55% B. 11.5% C. 12.98% D. 13%

2. A bank is advertising 9% accounts that yield 9.344% annually. How often is the interest
compounded?
A. daily B. monthly C. bimonthly D. quarterly

Continuous Compounding and Decreasing value

1. An amount of P25,000.00 is invested at 4.5% continuous compounding. Find the amount

after 10 years.

2. Suppose a car presently worth S8200 depreciates 20% per year. About how much will it be
worth 2 years and 3 months from now?

Break – even Analysis

1. XYZ Corporation manufactures bookcases that it sells for P70.00 each. It costs XYZ
P35,000 per year to operate its plant. The 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 a loss?

2. A steel drum manufacturer incurs a yearly fixed operation cost of $220,000. Each drum
manufactured costs $150 to produce and sells for $200. What is the manufacturer’s break
– even sales volume in drums per year?

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 TOPIC NO. 2 REVIEW OF ENGINEERING ECONOMY
(PROBLEM-SOLVING) PART 2

Annuity
Annuity – is a series of equal payments occurring at equal interval of time.
Types of Annuity
1. Ordinary Annuity
Payments that starts at the end of each period starting from the first period.
(𝑖+1)𝑛−1
A. 𝑃 = 𝑅 [ (1+𝑖)𝑛 𝑖
]
(1+𝑖)𝑛−1
B.𝐹 = 𝑅 [ 𝑖
]
𝑅 𝑅+𝐹𝑖
𝑙𝑛( ) 𝑙𝑛( )
𝑅−𝑃𝑖 𝑅
𝐶. 𝑛 = ln (1+𝑖)
or 𝑛 = ln(1+𝑖)

D. The most convenient solution in solving 𝑖 is by “trial and error” method by the substitution of
the given values in the given choices.
Where: P = present worth
F = future worth
𝑖 = interest rate per period = 𝑖𝑛 ⁄𝑚
n = no. of periods = m n
R = uniform amount per period
Problems
1. If you obtain a loan of P1M at the rate of 12% compounded annually in order to build a house,
how must you pay monthly to amortize the loan within a period of ten years?
2. A piece of machinery can be bought for P13,000 cash, or for P2000 down and payments of
P965 per year for 15 years. What is the annual interest rate for the time payments?
3. Mr. Richardson borrowed $16,000 two years ago. The repayment terms of the loan are 12%
interest for 10 yr and uniform annual payments. He just made his second payment. How much
principal, most nearly, does he still owe?
4. A company issued 54 bonds of P1,500 face value each, redeemable at par at the end of 15
years. To accumulate the funds required for redemption, the firm established a sinking fund
consisting of annual deposits, the interest rate of the fund being 5%. What was the principal in
the fund at the end of the 10 th year?
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5. The following schedule of funds is available to form a sinking fund.
𝑡 = 0 yr, $6000; 𝑡 = 1 yr, $5000; 𝑡 = 2 yrs, $4000; 𝑡 = 3 yrs, $3000
At the end of the fourth year, equipment costing $26,000 will have to be purchased as a
replacement for old equipment. Money is valued at 16% by the company. At the time of
purchase, how much money will be needed?

2. Deferred Annuity
Payments start at any period after the first period.
A. Solving for the present worth P.
(1+𝑖)6−1
First method: 𝑃1 = 𝑅 [ (1+𝑖)6𝑖
]

𝑃1
𝑃= (1+𝑖)4

𝐹 = 𝑃 (1 + 𝑖 )10

(1+𝑖)6−1
𝐹 =𝑅[ ]
𝑖

Problems
1. A man borrowed P100,000 at 11% compounded annually for 12 years. And promised to pay
the amount starting 5 years for now. Find the annual payment.
2. A student needs $4000/yr for 4 yrs to attend college. Her father invested $6000 in an 8%
account for her education when she was born. If the student withdraws $4000 at the end of
her 17𝑡ℎ , 18𝑡ℎ , 19𝑡ℎ , and 20𝑡ℎ years, how much money will be left in the account at the end of
her 21𝑡ℎ year?
3. Consider a project that involves the investment of $120,000 now and $120,000 at the end of
year 1. Revenues of $170,000 will be generated at the end of years 1 and 2. What is most
nearly the net present value of this project if the effective annual interest rate is 12%?

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3. Annuity Due
Payments start at the beginning of each period starting from n = 0.

(1+𝑖)9−1
A.𝑃 = 𝑅 [ (1+_𝑖)9 𝑖 ] + 𝑅

B.𝐹 = 𝑃(1 + 𝑖 )10

(1 + 𝑖 )10 − 1
𝐹 =𝑅[ ] (1 + 𝑖 )𝑖
𝑖

Problems
1. Mr. Johnson borrows $90,000 at 12% effective annual interest. He must pay back the loan
over 25 yrs with uniform monthly payments due on the first day of each month. Approximately
what amount does Mr. Johnson pay each month?
2. Determine the present worth and the accumulated amount of an annuity consisting of 6
payments of P12,000 each, the payment are made at the beginning of each year. Money is
worth 15% compounded annually.
3. $12,000 is invested at the beginning of a year in a 14% security and held for 6 yrs. During
that time, the average annual inflation is 6%. Approximately how much, in terms of year zero
dollars, will be in the account at maturity?

4. Perpetuity

Is an annuity that continues indefinitely(𝑛 → ∞)

R
𝑃= 𝑖
𝑅 = 𝑃𝑖

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Problem
A machine needs P5000 semi-annually for its maintenance during its perpetual life. If effective
interest is P16%, find the present amount of the maintenance.

UNIFORM GRADIENT CASH FLOW

1. for increasing value

(1+𝑖)𝑛−1 (1+𝑖)𝑛−1 𝑛
A. 𝑃 = 𝑅 [ (1+𝑖)𝑛𝑖
] ± 𝐺 [ (1+𝑖)𝑛
𝑖2
− (1+𝑖)𝑛𝑖 ]

(1+𝑖)𝑛−1 (1+𝑖)𝑛−1 𝑛
B.𝐹 = 𝑅 [ ±𝐺[ − ]]
𝑖 𝑖2 𝑖

G = gradient
Use + if the amount is increasing
Use – if the amount is decreasing

Problem
1. The maintenance cost of a machine this year is expected to be P6,000. The cost will increase
P600 each year for the subsequent 9 years. The interest is 14% compounded annually. What is
the approximate worth of maintenance for the machine over the full 10 years?
2. The cash flow associated with a stripper oil well is expected to be $8,000 in month one,
$7,900 in month two, and amounts decreasing by $100 each month through year four. At an
interest rate of 12% per year compounded monthly, the equivalent uniform monthly cash flow is
closed to: