ENGINEERING ECONOMY

SIMPLE AND COMPOUND INTEREST

LEARNING CONTENT

Economics
- Is a science which deals with the attainment of the maximum fulfilment
of society’s unlimited demands for goods and services.

Engineering Economics
- Is the branch of economics which deals with the application of economics
laws and theories involving engineering and technical projects or
equipments.

Consumer Goods and Services

- Refer to the products or services that are directly used by people to
satisfy their wants.
- Examples are food, clothing, shelter, etc.

Producer Goods and Services

- Are those that are used to produce the consumer goods and services.

2 Types of Goods and Sevices:

1. Necessity
- refers to the goods and services that are required to support human
life, needs and activities.

2. Luxuries
- are those goods and services that are desired by human and will be
acquired only after all the necessities have been satisfied.

Demand
- Is the need, want or desire for a product backed by the money to
purchase it.
- Demand is based on “willingness and ability to pay” for a product, not
merely want or need for the product.
- The demand for a product is inversely proportional to its selling price.

Supply
- Is the amount of a product made available for sale.
- If the selling price for a product is high, more producers will be willing to
work harder and risk more capital in order to reap more profit. However,
if the selling price for a product declines, capitalists will not produce as

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 much because of the smaller profit they can obtain for their labor and
risk.
- Therefore, the relationship between price and supply is that they are
directly proportional.

Interest
- Is the amount of money earned by a given capital.
- From the borrower’s viewpoint, interest is the amount of money paid for
the use of a borrowed capital.
- From the lender’s viewpoint,it is the income generated by the capital that
was lent.

Simple Interest
- Is defined as the interest on a loan or principal that is based only on the
original amount of the loan or principal.

Formula:
I = Pin
Where:
P = principal
i = interest
n = number of interest period

2 Types of Simple Interest:

1. Ordinary Simple Interest

- is based on one banker’s year. One banker’s year is equivalent to 12
monts of 30 days each.
- 1 banker’s year = 360 days

The value of n is:

d
n = 360

The simple interest is:

d
I = Pⅈ (360)

2. Exact Simple Interest

- is based on the exact number of days in a given year. A normal year
has 365 days while leap year (which occures one every 4 years) has 366 days. Unlike
the ordinary simple interest where each month has 30 days, in the type of simple
interest, the number of days in a month is based on the actual number of days each
month contains in our Gregorian calendar.

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 The value of n is:

For normal year:

d
n = 365

For leap year:

d
n = 366

Compound Interest
- Is defined as the interest of loan or principal which is based not only on
the original amount of the loan or principal but the amount of loan or
principal plus the previous accumulated interest. This means that aside
from the principal, the interest now earns interest as well. Thus, the
interest charges grow exponentially over a period of time.

Future Amount, F:

Formula:

F = P(1 + ⅈ)n

Where:
P = Principal
i = interest per period (in decimal)
n = number of interest periods
(1 + ⅈ)n = single payment compound amount factor

Present Worth, P:

Formula:

F
P = (1+ⅈ)n
Where:
1
(1+ⅈ)n
= single payment present worth factor

Example Problems:

1. P4,000 is borrowed for 75 days at 16% per annum simple interest. How much will
be due at the end of 75 days?

Solution:
F = P(1 + ⅈn)

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 75
F = 4,000 [1 + 0.16 (360)]
𝐅 = 𝐏 𝟒, 𝟏𝟑𝟑. 𝟑𝟑

2. What will be the future worth of money after 12 months, if the sum of P25,000 is
invested today at simple interest rate of 1% per month?

Solution:

F = P(1 + ⅈn)
F = 25,000(1 + 0.01(12))
𝐅 = 𝐏𝟐𝟖, 𝟎𝟎𝟎

3. A man borrowed P 20,000 from a local commercial bank which has a simple
interest of 16% but the interest is to be deducted from the loan at the time that the money
was borrowed and the loan is payable at the end of one yer. How much is the actual rate of
interest?

Solution:

I = 0.16 (20,000)
I = 3,200

I = Pin
3,200 = (20,000 – 3,200) (i) (1)
i = 0.19
i = 19%

4. Find the present worth of a future payment of P100,000 to be made in 10 years

with an interest of 12% compounded quarterly.

Solution:

F = P(1 + ⅈ)n
𝟎.𝟏𝟐 4(10)
100,000 = P (1 + )
𝟒
𝐏 = P30,655.68

5. Fifteen years ago P1,000.00 was deposited in a bank account, and today it is worth
P2,370.00. The bank pays interest semi-annually. What was the interest rate paid in this
account?

Solution:

F = P(1 + ⅈ)n
( )
𝐢 2 15
2,370 = 1,000 (1 + 𝟐)

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 2.37 = P(1 + 0.5ⅈ)30
ⅈ = 0.058
𝐢 = 𝟓. 𝟖%

Activity Problem

Solve the following Problems. Show your complete solution.

1. A deposit of P1,000 is made in a bank account that pays 8% interest compounded

annually. Approximately how much money will be in the account after 10 years?

2. If P5,000 shall accumulate for 10 years at 8% compounded quarterly, find the

compounded interest at the end of 10 years.

3. P1,500 was deposited in a bank account, 20 years ago. Today it is worth P3,000.
Interest is paid semi-annually. Determine the interest rate paid on this account.

4. By the condition of a will, the sum of P20,000 is left to a girl to be held in trust
fund by her guardian until it amounts to P50,000. When will the girl receive the money if the
fund is invested at 8% compounded quarterly.

5. A bank charges 12% simple interest on a P300.00 loan. Howmuch will be repaid if
the loan is paid in one lump sum after three years?

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