ENGINEERING

ECONOMY

Niel Arvin B. Galos

Simple Interest
- the interest earned by the principal is computed at
the end of the investment period.
0 t

P F
Future Worth : F = P + I
Interest earned : I = Prt
P = principal or present worth
r = simple interest rate ( per year )
t = time in years of fraction of a year
Ordinary simple interest
•the interest is computed on the basis of one
banker’s year ( 1 banker’s year = 360 days )
D
I =Pr
360
Exact simple interest
•the interest is based on the exact number of days in a
year ( ordinary year = 365 days, leap year = 366 days)
D
I =Pr
365 Niel Arvin B. Galos
Compound Interest
- the interest is computed every end of each interest period
(compounding period) and the interest earned for that period is
added to the principal.
0 n

P
F
Future Worth : F = P ( 1 + i )n
i = effective interest per interest period
no min al int erest rate
=
number of compounding per year
n = total number of compoundings

Single Payment Compound Amount Factor = ( 1 + i )n

Single Payment Present Worth Factor = ( 1 + i )-n

Niel Arvin B. Galos

To compute values of i and n:
nominal interest rate = 12 %
number of years of investment = 6 years

a. compounded annually
i = 0.12/1 = 0.12
n = 6(1) = 6
b. compounded semi-annually
i = 0.12/2 = 0.06
n = 6(2) = 12
c. compounded quarterly
i = 0.12/4 = 0.03
n = 6(4) = 24
d. compounded monthly
i = 0.12/12 = 0.01
n = 6(12) = 72
e. compounded bi-monthly
i = 0.12/6 = 0.02
n = 6(6) = 36

Continuous compounding
Future Worth : F = Pert
Niel Arvin B. Galos
Effective Rate of Interest, ER
Interest Earned in One Year
ER =
Pr incipal During that Year
m (1)
 NR 
P 1 +  −P
F−P  m 
ER = =
P P
m
 NR 
ER =  1 +  −1
 m 

Equivalent Rates

ER1 = ER2
m1 m2
 NR1   NR2 
1 +  = 1 + 
 m1   m2 

Effective Rate of Interest for Compounded Continuously

ER = er − 1
Niel Arvin B. Galos
Annuity
- is a series of uniform payments made at equal intervals of time.

i.) as payment of a debt by a series of equal payment at equal time

intervals, also known as amortization.

ii.) to accumulate a certain amount in the future by depositing equal

amounts at equal time intervals, these amounts are called sinking fund.

iii.) as a substitute periodic payment for a future lump sum payments.

Niel Arvin B. Galos

Ordinary Annuity
- the payments is made at the end of each period starting from
the first period.
0 1 2 3 4 n

A A A A A

A [ (1 + i)n - 1 ] F
Future Worth : F =
i
0 1 2 3 4 n

A A A A A

P
A [ (1 + i)n - 1 ]
Present Worth : P =
(1 + i)n i
Niel Arvin B. Galos
 A = periodic payment
P = present worth of all periodic payments
F = future worth of all the periodic payments after the
last payment is made
i = interest rate per payment
n = number of payments
(1 + i ) n - 1
Compound Amount Factor: CAF =
i
(1 + i ) n - 1
Present Worth Factor : PWF =
(1 + i ) n i
(1 + i ) n i
Capital Recovery Factor : CRF =
(1 + i ) n − 1

Uniform Payment Series with Continuous Compounding

A [ 1- ern ] er n -1
Present Worth : P = CAF = r
er - 1 e -1
A [ e rn - 1] 1 - e -r n
Future Worth : F = PWF =
er - 1 er -1
Niel Arvin B. Galos
Deferred Annuity
- the first payment is deferred a certain number of periods after
the first.
0 1 2 3 4 n

A A A A
x(pcs)
P1
P0

P1 =
[
A (1 + i ) − 1
x
]
i (1 + i )
x

P1
P=
(1 + i )1

Niel Arvin B. Galos

Annuity Due
- the payment is made at the beginning of each period starting from
the first period.

0 1 2 3 4 n

A A A A A A

F1

P F2

P = A+
[
A (1 + i ) − 1
n −1
]
i (1 + i )
n −1

F=
[
A (1 + i )
n +1
−1 ]− A
i
Niel Arvin B. Galos
Perpetuity
- is an annuity where the payment periods extend forever or the
periodic payments continue indefinitely.

A
Present worth of perpetuity : P =
i

Depreciation
- is the decrease in the value of an asset due to usage of passage
of time.

cost

FC = first cost
Dm Dm = total depreciation after m
D years
FC BVm = book value after m years
BVm m = any time before n
SV n = life of the property in years
SV = salvage value
0 m n time

Niel Arvin B. Galos

Methods of Computing Depreciation
1. Straight Line Method

FC - SV
Annual Depreciation =
n
FC - SV
Total Depreciation after m years = (m)
n
Book Value = First Cost – Depreciation

2. Sinking Fund Method

(FC - SV) i
Annual Depreciation =
(1 + i)n - 1

A [ (1 + i) m - 1 ]
Total Depreciation after m years =
i

Niel Arvin B. Galos

3. Declining Balance Method (Mathesons Method)

Depreciation at the mth year = FC ( 1 – k )m-1 k

k = annual rate of depreciation

n
SV
=1-
FC
1
 SV  n
1- k =  
 FC  m
 SV  n
Book value at the mth year = FC (1 – k)m = FC  
 FC 
4. Double Declining Balance Method

Depreciation at the mth year = FC ( 1 – k )m-1 k

k = annual rate of depreciation

2
=
n
Book value at the mth year = FC (1 – k)m

Niel Arvin B. Galos

5. Sum of Years Digit Method

Life of Property, n = 10

∑ years = (n + 1) = 55
n
2
(FC − SV ) n
Depreciation at the 1st year =
∑ years

(FC − SV ) (n − 1)
Depreciation at the 2nd year =
∑ years

(FC − SV )[n + (n − 1)]

Total Depreciation at the end of 2nd year =
∑ years
Year Depreciation
1 (FC – SV) 10/55
2 (FC – SV) 9/55

Niel Arvin B. Galos

6. Modified Accelerated Cost Recovery System, MARCS
Assumption: A shift from SL to DDM
11 
d1 =  FC − 0 
2n 

d2 =
2
(FC − d1 )
n

d 3 = (FC − d1 − d 2 )
2
n

Annual Cost, AC
AC = annual interest of investment
+ annual operation and maintenance
+ annual depreciation cost
(FC - SV) i
AC = (FC)i + OC +
(1 + i)n - 1

Niel Arvin B. Galos

Capitalized Cost
Annual Cost
=
i
Benefit Cost Ratio
Pr esent Worth of Benefits
=
Pr esent Worth of Cost
Payout Period
Fixed Capital Investment
=
Annual Pr ofit + Annual Depreciation
Recovery Period
Total Investment
=
Annual Pr ofit

Rate of Return, ROR

Net Annual Income
=
Initial Investment
Niel Arvin B. Galos
Inflation
- increased in amount of money needed to purchase same amount of
goods or services.

Two ways to work problems when considering inflation:

(1) Convert to constant value (CV) , then use real rate i.
If f = inflation rate (% per year), the equation is:

Constant-value = future value

(1+ f)n
(2) Leave money amounts as is and use interest rate adjusted
for inflation, if
if = i + f + (i)(f)

Niel Arvin B. Galos

Break–even Analysis
- examines the short run relationship between changes in volume
and changes in total sales revenue, expenses and net profit.

- Also known as C-V-P analysis (Cost Volume Profit Analysis).

Cost Revenue or Sales

Break
Even
Total Cost
Point Profit

Variable Cost
Loss

Fixed Cost

Quantity, x

Revenue, R = amount is dependent on quantity sold

Total Cost, TC = Sum of fixed and variable cost = FC + VC
Profit, P = R – TC = R – (FC + VC)

Break Even Point, set R = TC

Niel Arvin B. Galos