An Engineering Science

ENGINEERING ECONOMY

University of Eastern Philippines

College of Engineering

Engr. Elaido B. Jao Jr.

Instructor
Agricultural & Biosystems Engineering Department

2020
 ES 414a: ENGINEERING ECONOMY

MODULE 2: AMORTIZATION, DEPRECIATION AND VALUATION

OVERVIEW

This module tackles on the amortization scheduling, deprecation and valuation of

materials particularly the essentials of Engineering Economy and their functions

TOPICS:

This module presents the following topics:

1. Amortization,
a. Deferred Annuity/Annuity Due
b. Perpetuity
c. Capitalized Cost
d. Amortization Schedule
e. Uniform Arithmetic Gradient
2. Depreciation and Valuation
a. Depreciation methods
b. Valuation

LEARNING OUTCOMES

At the end of this course, the student must be able to

1. Determine the amortization value of an investment and the Depreciation and

Valuation of the future amount;
2. Prepare detailed scheduling of the amortization and depreciation value and its
valuation schedule equivalent.

PRETEST

Direction: Choose the letter of the correct answer. Do not write your answer on this
manual.
1. Annuities involved:
a. to determine the capital investment costs c. payment at equal time intervals
b. all payments of equal amount d. all of the above
2. The decrease of the value of physical property with the passage of time.
a. value b. book value c. depreciation d. amortization
3. The present worth of all future profits that are to be received through ownership of a
particular property.
a. value b. book value c. fair value d. scrap value
4. In a cash flow series:
a. Uniform gradient signifies that an income or disbarment changes by the same
amount in each interest period.
b. Either an increase or decrease in the amount of a cash flows is called the
disbursement
 c. The gradient in the cash flow may always be positive.
d. All of the above
5. It is the price that can be obtained from the sale of the property after it has been used
a. salvage value b. book value c. fair value d. scrap value
6. All are requirements of depreciation except:
a. It should be simple.
b. It should recover capita.
c. The book value will be reasonably close to the market value at any time
d. The method should be accepted by the department of finance.
7. A depreciation value is directly proportional to the age of property.
a. straight line b. sinking fund c. declining balance d. double declining
8. It is determine by a disinterested party in order to establish a price that both seller and
buyer agreed.
a. value b. book value c. fair value d. scrap value
9. All are legal rights of common stock holder except:
a. Vote at stockholders’ meetings
b. Make but cannot amend the by-laws of the corporation
c. Subject to the government approval, amend, or change the charter or capital
structure.
d. Inspect the books of the corporation.
10. The name of the owner of this bond is recorded on the record books of the
corporation and the interest payments are sent to the owner periodically without any
action on his part.
a. book value bonds c. registered bonds
b. coupon bonds d. time deposit bonds
.

Key Terms

Amortization is an accounting technique used to periodically lower the book value of a

loan or intangible asset over a set period of time. In relation to a loan, amortization
focuses on spreading out loan payments over time. When applied to an asset,
amortization is similar to depreciation.
Annuity. A series of equal amounts at equal time intervals. Also see annuity due, annuity
in advance, annuity in arrears, and ordinary annuity.
Capitalized Cost is an expense that is added to the cost basis of a fixed asset on a
company's balance sheet. Capitalized costs are not expensed in the period they
were incurred but recognized over a period of time via depreciation or amortization.
Depreciation is an accounting method of allocating the cost of a tangible or physical
asset over its useful life or life expectancy. Depreciation represents how much of an
asset's value has been used up
Gradients are special cases where a series of cash flows consists of regular, unequal
amounts that increase or decrease following a specific pattern.
Gradients Factors are the factors used to calculate equivalent P,A and F for such series
of cash flows.
Perpetuity. a bond or other security with no fixed maturity date.
Valuation is the process of determining the present value (PV) of an asset. Valuations
can be done on assets (for example, investments in marketable securities such as
stocks, options, business enterprises, or intangible assets such as patents and
trademarks) or on liabilities (e.g., bonds issued by a company).

What to know
Do you want to use your money properly? Let’s find out how.
Let's get started:

INTRODUCTION

The need for engineering economy is primarily motivated by the work that engineers do in
performing analyses, synthesizing, and coming to a conclusion as they work on projects of
all sizes. In other words, engineering economy is at the heart of making decisions. These
decisions involve amortization, depreciation and valuation that will lead to better decisions
in using money properly..

DEFERRED ANNUITY

A deferred annuity is one where the first payment is made several periods after the
beginning of the annuity.

Finding P where A is Given

m periods n periods

0 1 2 n-1 n
0 1 2 n

A A A A

A(P/A,i%,n)(P/F,i%,m A(P/A,i%,n)(

Cash flow diagram given A to find P

P = A (P/A, i%, n)(P/F, i%, m) Eq. 1

( )
P = A (1 + 𝑖 ) Eq. 2

EXAMPLE 1

If ₱10,000 is deposited each year for 9 years, how much annually can a person get
annually from the bank every year for 8 years starting 1 year after the 9th deposit is made.
Cost of money is 14%.

Given: uniform deposit = ₱ 10,000 n1 = 8 n2 = 9 i = 14%

Required Annuity , A

Solution
Using today as the focal date, the equation of value is

( ) ( )
A (1 + 𝑖 ) = ₱10,000

A (P/A, 14%, 8)(P/F, 14%, 9) = ₱10,000 (P/A, 14%, 9)

( . ) ( . )
A (1 + 0.14) = ₱10,000
. .
A (4.63886)(0.30751) = ₱10,000 (4.94637)

A = ₱ 34,675

ANNUITY DUE

An annuity due is one where the payment are made at the beginning of each period.

Find P when A is Given

0 1 2 3 - - - n-1 n

A A A A A

Cash flow diagram given A to find P

P = A + A(P/A, i%, n-1) Eq. 3

P = A (1 + P/A, i%, n-1) Eq. 4

Find F when A is Given

0 1 2 3 - - - n-1 n

A A A A A

Cash flow diagram given A to find F

F = A (F/A, i%, n+1) - A Eq. 5

P = A [ (F/A, i%, n+1) - 1] Eq. 6

EXAMPLE 2

A man bought an equipment costing ₱60,000 payable in 12 quarterly payments each

installment payable at the beginning of each period. The rate of interest is 24%
compounded quarterly. What is the amount of each payment?
Given: P = ₱ 60,000
n = 12 - 1 = 11
%
I = = 8%

Required Annuity , A

Solution
P = ₱ 60,000

1 2 3 4 5 6 7 8 9 10 11 12

A A A A A A A A A A A A
𝑛
1+𝑖 −1
P = A +A 𝑛 from Eq 3
𝑖 1+𝑖

A = (1+𝑖) 𝑛 −1
𝑖(1+𝑖) 𝑛

₱ ,
A = ( )
.
. ( . )

A = ₱ 7,371.94

EXAMPLE 3

A certain property is being sold and the owner received two bids.

The first bidder offered to pay ₱400,000 each year for 5 years, each payment is to be
made at the beginning of each year. The second bidder offered to pay ₱ 240,000 first
year, ₱360,000 the second year and ₱ 540,000 each year for the next 3 years, all will be
made at the beginning of each year.

If money is worth 20% compounded annually, which bid should the owner of the property
accept ?

Solution

First Bid

Given:

Let P1 = present worth of the first bidder

A = ₱ 400,000
n = 5–1 =4
I = 20%

Required P1
 P1

0 1 2 3 4 5

₱ 400,000 ₱ 400,000 ₱ 400,000 ₱ 400,000 ₱ 400,000

𝑛
1+𝑖 −1
P1 = A+A 𝑛
𝑖 1+𝑖
𝑛
1+𝑖 −1
P1 = A 1+ 𝑛
𝑖 1+𝑖
( . )
P1 = ₱ 400,000 1+ ( )
. .

P1 = ₱ 1,435,493.83

Second Bid

Given:

Let P2 = present worth of the second bidder

F1 = ₱ 240,000
F2 = ₱ 360,000
F3 = ₱ 540,000
n = 5
I = 20%

Required P2

P2

0 1 2 3 4 5

₱ 240,000 ₱ 360,000 ₱ 540,000 ₱ 540,000 ₱ 540,000

P2 = ₱240,000 + ₱360,000(P/F, 20%,1) + ₱540,000(P/A, 20%,3)(P/F,20%,1)

P2 = ₱240,000 + ₱360,000(0.8333 + ₱540,000(2.1065)(0.8333)

P2 = ₱ 1,487,875

THEREFORE: The owner of property should accept the second bid.

PERPETUITY

Perpetuity is an annuity in which the payments continue indefinitely.

0 1 2 3 n -∞

A A A

Cash flow diagram to find P given A

∞
( )
P = A = Eq. 7

EXAMPLE 4

What amount of money invested today at 15% interest can provide the following
scholarship: ₱ 30,000 at the end of each year for 6 years, ₱40,000 for the next 6 years
and ₱50,000 thereafter?

Given: A1 = ₱ 30,000, n = 6 yrs

A2 = ₱ 40,000 n = next 6 yrs
A3 = ₱ 50,000 n = ∞ yrs
i = 15%

Required Present Worth , P

Solution:
 ₱ ,
P = ₱30,000 (P/A, 15%,6) + ₱40,000(P/A,15%,6)(P/F,15%,6) + (P/F,15%,12)
.
₱ ,
P = ₱30,000(3.7845) + ₱40,000(3.7845)(0.4323) + (0.1869)
.
P = ₱ 241,277

CAPITALIZED COST

One of the most important applications of perpetuity is in capitalized cost. The capitalized
cost of any property is the sum of the first cost and the present worth of all costs of
replacement, operation and maintenance for a long time or forever.

Case 1: No replacement, only maintenance and or operation every period.

Capitalized Cost = First Cost + Present worth of perpetual operation and or

maintenance

EXAMPLE 5

Determine the capitalized cost of a structure that requires an initial investment of

₱1, 500,000 and an annual maintenance of ₱150,000. Interest is 15%.

Given: First Cost = ₱ 1,500,000 A = ₱150,000 i = 15%

Required capitalized cost

Solution:

₱150,000 ₱150,000

0 1 2 ∞

P
₱ ,
P = = = ₱1,000,000
.

Capitalized Cost = First Cost + P

= ₱1,500,000 + ₱1,000,000
Capitalized Cost = ₱2,500,000

Case 2: Replacement only, no maintenance and or operation

Capitalized Cost = First Cost + Present worth of perpetual replacement

Let S = amount needed to replace a property every k periods

X = amount of principal investment at rate i% the interest on which will amount
to S every k periods
Xi = interest on X every periods, the periodic deposit towards the accumulation
of S
 S

0 1 2 3 k-1 k

Xi Xi Xi Xi Xi

Cash flow diagrams to find X given S

S = Xi (F/A , i%, k)

X = =
/ , %, ( )

X = Eq. 8
( )

Difference between P and X in a perpetuity

P is the amount invested now at i% per period whose interest at the end of every period
forever is A while X is the amount invested now at i% per period whose interest at the end
of every k periods forever is S. If k = 1, then X = P.

EXAMPLE 6

A new engine was installed by a textile plant at a cost ₱ 300,000 and projected to have a
useful life of 15 years. At the end of its useful life, it is estimated to have a salvage value of
₱30,000. Determine its capital cost if interest is 18% compounded annually.

Given: First Cost = ₱ 300,000 A = ₱30,000 n = 15yrs. i = 18%

Required capitalized cost

Solution:
 ₱ ,
X = = = ₱ 24,604
( ) ( . )
Capitalized Cost = First Cost + X = ₱ 300,000 + ₱ 24,604

Capitalized Cost = ₱ 324,604

Case 3: Replacement , maintenance and or operation every period

Capitalized Cost = First Cost + Present worth of cost of perpetual operation and
or maintenance + Present worth of cost of perpetual
replacement

Example 7:

Determine the capitalized cost of a research laboratory which requires ₱5,000,000 for
original construction; ₱100,000 at the end of every year for the first 6 years and then
₱120,000 each year thereafter for operating expenses, and ₱500,000 every 5 years for
replacement of equipment with interest at 12% per annum ?

Given: First Cost = ₱ 5,000,000 A = ₱100,000; n = 6 yrs

S = ₱ 500,000, n = 5yrs, i = 12%

Required capitalized cost

Solution:
Operation:

Let Q = the present worth of cost of perpetual operation

₱ ,
Q = ₱100,000(P/A, 12%, 6) + (P/F, 12%, 6)
.
₱ ,
Q = ₱100,000(4.1114) + (0.5066)
.
Q = ₱ 917,740

Replacement:

₱ 500,000 ₱ 500,000 ₱ 500,000

0 5 10 15

Let X = the present worth of cost of perpetual replacement

₱ ,
X = = = ₱ 655,910
( ) ( . )

Hence:

Capitalized Cost = First Cost + Q + X

= ₱ 5,000,000 + ₱ 917,740 + ₱ 655,910
Capitalized Cost = ₱ 6,753,650
AMORTIZATION

Amortization is any method of repaying a debt, the principal and interest included, usually
by a series of equal payments at equal interval of time.

Example 8:

A debt of ₱ 5,000 with interest at 12% compounded semiannually is to be ammortized by

equal semiannual payments over the next 3 years, the first due in 6 months. Find the
semiannual payment and construct an amortization schedule.
%
Given: P = ₱ 5,000 i = = 6% n=3x2=6

Required semiannual payments & amortization schedule

Solution:

₱ 5,000

0 1 2 3 4 5 6

A A A A A A

₱ ,
A = = = ₱ 1,016.82
/ , %, .

Constructing the Amortization Schedule

Outstanding
Interest due Payment
principal at
Period at end of Payment repaid at end
beginning of
period of period
period
1 ₱ 5,000.00 ₱ 300.00 ₱ 1,016.82 ₱ 716.82
2 4,283.18 256.99 1,016.82 759.83
3 3,523.35 211.40 1,016.82 805.42
4 2,717.93 163.08 1,016.82 853.74
5 1,864.19 111.85 1,016.82 904.97
6 959.22 57.55 1,016.82 959.27
Total ₱ 1,100.87 ₱ 6,100.92 ₱ 5,000.05

Example 9:

A debt of ₱ 10,000 with interest rate at 20% compounded semiannually is to be

ammortized by 5 equal payments at the end of each 6 months, the first payment is to be
made after 3 years. Find the semiannual payment and construct an amortization schedule.
%
Given: P = ₱ 10,000 i = = 10% n=5
Required semiannual payments & amortization schedule

Solution:

₱ 10,000

0 1 2 3 4 5
0 1 2 3 4 5 6 7 8 9 10

A A A A A

P = A (P/A, 10%, 5) (P/F, 10%, 5)

A = P (A/P, 10%, 5) (F/P, 10%, 5)
A = P (1 + 𝑖 )
( )
.
A = P (1 + 0.10)
( . )
A = ₱10,000 (0.2638) (1.6105)
A = ₱4,248.50

Constructing the Amortization Schedule

Outstanding
Interest due Payment
principal at
Period at end of Payment repaid at end
beginning of
period of period
period
1 ₱ 10,000.00 ₱ 1,000.00
2 11,000.00 1,100.00
3 12,100.00 1,210.00
4 13,310.00 1,331.00
5 14,641.00 1,464.10
6 16,105.10 1,610.51 ₱ 4,284.50 ₱ 2,637.99
7 13,467.11 1,346.71 4,284.50 2,901.79
8 10,565.32 1,056.53 4,284.50 3,191.97
9 7,373.35 737.34 4,284.50 3,511.16
10 3,862.19 386.22 4,284.50 3,862.28
Total ₱ 11,242.41 ₱ 21,242.50 ₱ 16,105.19

UNIFORM ARITHMETIC GRADIENT

In certain cases, economic analysis problems involve receipts or disbursements that

increase or decrease by a uniform amount each period. For example, maintenance and
repair expenses on specific equipment or property may increase by relatively constant
amount each period. This is known as a uniform arithmetic gradient.

Suppose that the maintenance expense on a certain machine is ₱ 1,000 at the end of the
first year and increasing at a constant rate of ₱ 500 each year for the next four years.
 G is known as the uniform gradient amount

P = PA + PG Eq. 9
Where
PA = A (P/A, i%, n) Eq. 10

PG = G (1 + i)-2 + G (1 + i)-3 + G (1 + i)-4 + …+(n-1) G (1 + i)-(n-1)

( )
PG = −𝑛 ( )
Eq. 11

PG = G (P/G, i%, n) Eq. 12

( )
Where P/G, i%, n = −𝑛 ( )
, this factor is called the gradient to
present worth conversion factor. Thus,

P = A (P/A, i%, n) + G (P/G, i%, n) Eq. 13

Example 10:

A loan was to be amortized by a group of four-end-of-year payments forming an ascending

arithmetic progression. The initial payment was to be ₱ 5,000 and the difference between
successive payments was to be ₱ 400. But the loan was renegotiated to provide for the
payment of equal rather than uniformly varying sums. If the interest rate of the loan was
15%, what was the annual payment?

Given: A = ₱ 5,000 , G = ₱ 400 n =4 i = 15%

Required Annual payment

Solution:
 Let A = the annual payment
So,
( )
P/A, 15%, 4 =
( . )
P/A, 15%, 4 =
.
P/A, 15%, 4 = 2.8550
Hence,
( )
P/G, 15%, 4 = −𝑛 ( )
,
( . )
P/G, 15%, 4 = −4 ( )
. . .
P/G, 15%, 4 = 3.7865
Thus,
P = A (P/A, i%, n) + G (P/G, i%, n)
P = (₱5,000) (2.8550) + (₱400)(3.7865)
P = ₱ 15,789.60

But: P = A(P/A, i%, n)

P = A (P/A, 15%, 4)
A =
( / , %, )
₱ , .
A =
.
A = ₱ 5,530.51
Example 11:

Find the equivalent annual payment of the following obligations at 20% interest.
End of Year Payment
1 ₱ 8,000
2 7,000
3 6,000
4 5,000

Given: A = ₱ 8,000 , G = ₱ 1,000 n =4 i = 20%

Required Annual payment

Solution:

Let A = the equivalent annual payment

So,
( )
P/A, 20%, 4 =
( . )
P/A, 20%, 4 =
.
P/A, 20%, 4 = 2.5887
Hence,
( )
P/G, 20%, 4 = −𝑛 ( )
,
( . )
P/G, 20%, 4 = −4 ( )
. . .
Thus,
P = A (P/A, i%, n) + G (P/G, i%, n)
P = (₱8,000) (2.5887) + (₱1,000)(3.2986)
P = ₱ 17,411

But: P = A(P/A, i%, n)

P = A (P/A, 20%, 4)
A =
( / , %, )
₱ ,
A =
.
A = ₱ 6,725.77

PROBLEM SET 1:

1. M purchased a small lot in a subdivision paying ₱ 200,000 down and promising to pay
₱ 15,000 every 3 months for the next 10 years. The seller figured interest is 12%
compounded quarterly.
a. What was the cash price of the lot?
b. If M missed the first 12 payments, what must be pay at the time the 13th is due
to bring himself up to date?
c. After making 8 payments, M wished to discharge his remaining indebtedness by
a single payment at the time when the 9th regular payment was due. What must
he pay in addition to the regular payment then due?
d. If M missed the first 10 payments, what must he pay when 11th payment is due
to discharge his entire indebtedness?

2. .A man approaches the ABC Loan Agency for ₱100,000 to be paid in 24 monthly
installments. The agency advertises an interest rate of 1.5% per month. They proceed
to calculate the amount of the monthly payment in the following manner:
Amount requested ₱ 100,000
Credit Investigation 500
Credit risk insurance 1,000
Total ₱ 101,500

Interest: (₱ 101,500)(24)(0.015) = ₱ 36,540

Total Owed: ₱ 101,500 + ₱ 36,540 = ₱ 138,040

₱ ,
Payment = = ₱ 5,751.67
What is the effective rate of interest of the loan?

3. A new office building was constructed 5 years ago by a consulting engineering firm. At
that time the firm obtained the bank loan for ₱ 10,000,000 with a 20% annual interest
rate, compounded quarterly. The terms of the loan called for equal quarterly payments
for a 10-year period with the right of prepayment at any time without penalty.

Due to internal changes in the firm, it is now proposed to refinance the loan through an
insurance company. The new loan is planned for a 20-year term with an interest rate of
24% per annum, compounded quarterly. The insurance company has a one time
service charge of 5% of the balance. This new loan also calls for equal quarterly
payments.
a. What is the balance due on the original mortgage (principal) if all payments
have been made through a full five years?
 b. What will be the difference between the equal quarterly payments in the existing
arrangement and the revised proposal?

4. An asphalt road requires no upkeep until the end of 2 years when ₱ 60,000 will be
needed for repairs. After this ₱ 90,000 will be needed for repairs at the end of each
year for the next 5 years., then ₱ 120,000 at the end of each year for the next 5 years,

If money is worth 14% compounded annually, what was the equivalent uniform annual
cost for the 12-year period? .

5. .A man wishes to provide a fund for his retirement such that from his 60th to 70th
birthdays he will be able to withdraw equal sums of ₱ 18,000 for his yearly expenses.
He invests equal amount for his 41st to 59th birthdays in a fund earning 10%
compounded annually. How much should each of these amounts be?

6. Determine the present worth and the accumulated amount of an annuity consisting of
an annuity consisting of 6 payments of ₱ 120,000 each, the payment are made at the
beginning of each year. Money is worth 15% compounded annually,

7. Calculate the capitalized cost of a project that has an initial cost of ₱ 3,000,000 and an
additional investment cost of ₱ 1,000,000 at the end of every ten years. The annual
operating cost will be ₱ 100,000 at the end of every year for the first four years and
₱ 160,000 thereafter. In addition, there is expected to be a recurring major rework
cost of ₱ 300,00 every 13 years. Assume i = 15%

8. The will of a wealthy philanthropist left ₱ 5,000,000 to establish a perpetual charitable

foundation. The foundation trustees decided to spend ₱ 1,200,000 to provide
₱ 100,000 of capital replacement at the end of each 5-year period. If the invested
funds earned 12% per annum, what would be the year-end amount available in
perpetuity from the endowment for charitable purpose? ,

9. The surface area of a certain plant that requires painting is 8,000 ft 2 Two kinds of
paint are available whose brands are A and B. Paint A costs ₱1.40 per ft 2 but needs
renewed at the end of every 4 years, while Paint B costs ₱ 1.80 per ft2 . If money is
worth 12% effective, how often should paint B be renewed so that it will be as
economically as Paint A?

10. A contract has been signed to lease a building at ₱ 200,000 per year with an annual
increase of ₱1,500 for 8 years. Payments are to be made at the end of each year,
starting one year from now. The prevailing interest rate is 7%. What lump sum paid
today would be equivalent to the 8-year lease-payment plan?
.

DEPRECIATION
.
Depreciation is the decrease in the value of physical property with the passage of time.

Definitions of Value

Value, in commercial sense, is the present worth of all future profits that are to be received
through ownership of a particular property.

The market value of a property is the amount which a willing buyer will pay to a willing
seller for the property where each has equal advantage and is under no compulsion to buy
or sell.
 The utility or use value of a property is what the property is worth to the owner as an
operating unit.

Fair value is the value which is usually determined by a disinterested third party in order to
establish a price that is fair to both seller and buyer.

Book value, sometimes called depreciated book value, is the worth of a property as shown
on the accounting records of an enterprise.

Salvage, or resale, value is the price that can be obtained from the sale of the property
after it has been used.

Scrap value is the amount the property would sell for if disposed off us junk. .

Purposes of Depreciation

1. To provide for the recovery of capital which has been invested in physical property
2. To enable the cost of depreciation to be charged to the cost of producing products or
services that results from the use of the property.

Types of Depreciations

1. Nominal depreciation
a. Physical depreciation - is due to the lessening of the physical ability of a
property to produce results. Its common causes are wear and deterioration
b. Functional. depreciation - is due to the lessening in the demand for the function
which the property was designed to render. Its common causes are inadequacy,
changes in styles, population center shift, saturation of markets or more efficient
machines are produced
2. Depreciation due to changes in price levels - is almost impossible to predict and
therefore is not considered in economy studies.
3. Depletion – refers to the decrease in the value of a property due to the gradual
extraction of its contents.

Requirements of a Depreciation Method

1. It should be simple
2. It should recover capital
3. The book value will be reasonably close to the market value at any time.
4. The method should be accepted by the Bureau of Internal Revenue.

Depreciation Methods

1. The Straight Line Method

This method assumes that the loss in value is directly proportional to the age of the
property.

d = Eq. 14
( )
Dn = Eq. 15

Cn = Co - Dn Eq. 16
 Where: d = the annual cost of depreciation
Co = the original cost
CL = the value at the end of the life, the scrap value
(including gain or loss due to removal)
L = useful life of the property in years
Dn = depreciation up to age n years
Cn = the book value at the end of n years

Example 12:

An electronic balance costs ₱ 90,000 and has an estimated salvage value of ₱ 8,000 at
the end of its 10 years life time. What would be the book value after three years, using the
straight line method in solving for the depreciation?

Given: Co = ₱ 90,000, CL = ₱ 8,000 L = 10 n=3

Required book value Cn (using the straight line method)

Solution:

₱ , ₱ ,
d = = = ₱ 8,200
( ) (₱ , , )
Dn = = = ₱ 24,600

Cn = Co - Dn = ₱ 90,000 - ₱ 24,600 = ₱ 65,400

2. The Sinking Fund Method

This method assumes that a sinking fund established in which funds will accumulate for
replacement. The total depreciation that has taken place up to any given time is assumed
to be equal to the accumulated amount in the sinking fund at that time.

Dn Co - CL

0 1 2 3 n L

d d d d d

d = Eq. 17
/ , %,
Dn = d (F/A, i%, L) Eq. 18

Cn = Co - Dn Eq. 19
Example 13

An electric cooperative purchased an equipment for ₱ 53,000 and ₱ 1,500 for freight
and delivery charges to the job site. The equipment has a normal life of 10 years with a
trade-in value of ₱ 5,000 against the purchase of a new equipment at the end of the life.
a. Determine the annual depreciation cost by the straight line method.
b. Determine the annual depreciation cost by the sinking fund method. Assume
interest at 6.5% compounded annually.

Given: Co = ₱ 53,000 + ₱1,500 = ₱54,500

CL = ₱ 5,000
L = 10
i = 6.5%

Required a. depreciation (using the straight line method)

b. depreciation (using the sinking fund method)

Solution:

a. Using the straight line method

₱ , ₱ ,
d = = = ₱ 4,950

b. Using the sinking fund method

₱ , ₱ , ₱ , ₱ ,
d = = =
/ , %, / , %, ( . )
.
₱ ,
=
.
= ₱ 3,668

Example 14

An industrial plant bought an equipment for ₱ 56,000. Other expenses including

installation amounted to ₱ 4,000. The equipment is expected to have a life of 16 years with
a salvage value of 10% of the original cost. Determine the book value at the end of 12
years by (a) the straight line method and (b) sinking fund method at 12% interest.

Given: Co = ₱ 56,000 + ₱4,000 = ₱60,000

CL = ₱ 60,000 x 10% = ₱6,000
L = 16
n = 12
i = 12%

Required a. book value Cn (using the straight line method)

b. book value Cn (using the sinking fund method)

Solution:

a. Using the straight line method

₱ , ₱ ,
d = = = ₱ 3,375
 ( ) (₱ , ₱ , )
Dn = = = ₱ 40,500

Cn = C o - Dn = ₱ 60,000 - ₱ 40,500 = ₱ 19,500

b. Using the sinking fund method

₱ , ₱ , ₱ , ₱ ,
d = = = ( . )
/ , %, / , %,
.
₱ ,
= = ₱ 1,263.06
.

Dn = d (F/A, 12%, 12)

12
(1+0.12) − 1
= (₱1,263.06)
0.12
Dn = ₱ 30,481.59

Cn = C o - Dn

= ₱ 60,000 - ₱ 30,481.59

Cn = ₱ 29,518.41

3. Declining Balance Method

In this method, sometimes called the constant percentage method or the Matheson
Formula, it is assumed that the annual cost of depreciation, is fixed percentage of the
salvage value at the beginning of the year. The ratio of the depreciation in any year to the
book value at the beginning of the year is constant throughout the life of the property and
is designated by k, the rate of depreciation..
Declining Balance Method Matrix Schedule

Book value at Depreciation Book value at the end of

Year
Beginning of Year
1 Co
2 Co (1 - k)
3 Co (1 - k)2
- -
N Co (1 - k)n-1
- -
L Co (1 - k)L-1
during the year year
d1 = k Co C1 = C0 - d1 = Co (1 - k)
d 2 = k C1 C2 = C1 – d2 = Co (1 - k)2
d 3 = k C2 C3 = C2 – d3 = Co (1 - k)3
- -
D n = k Cn-1 Cn = Cn-1 – dn = Co (1 - k)n
- -
d L = k CL-1 CL = CL-1 – dL = Co (1 - k)L

Dn = Co (1 – k ) n-1 k Eq. 20

Cn = Co (1 – k ) n = C Eq. 21

CL = Co (1 – k ) L Eq. 22

k = 1− = 1− Eq. 23

This method does not apply, if the salvage value is zero, because it will be equal to one
and d1 will be equal to Co.

Example 15

A certain type of machine loses 10% of the value each year. The machine costs ₱2,000
originally. Make out a schedule showing the yearly depreciation, the total depreciation and
the book value at the end year for 5 years

Given: Co = ₱ 2,000
CL = ₱ 2,000 x 10% = ₱200
L = 5

Required Construct a matrix schedule showing the following.

a. depreciation, Dn (using the straight line method)
b. book value Cn (using the sinking fund method)

Solution:

Declining Balance Method Matrix Schedule

Book value at Depreciation Total Book value at

Year Beginning of during the depreciation at the end of
Year year, 10% the end of year year
1 ₱ 2,000.00 ₱ 200.00 ₱ 200.00 ₱ 1,800.00
2 1,800.00 180.00 380.00 1,620.00
3 1,620.00 162.00 542.00 1,458.00
4 1,458.00 145.80 687.80 1,312.20
5 1,312.20 131.22 819.12 1,180.96
4. Double Declining Balance (DDB) Method

This method is very similar to the declining balance method except that the rate of
depreciation k is replaced by 2/L.

Dn = Co (1 - ) n-1 Eq. 24

Cn = Co (1 - )n Eq. 25

CL = Co (1 - )L Eq. 26

When the DDB method is used, the salvage value should not be subtracted from the first
cost when calculating the depreciation charge.

Example 16

Determine the rate of depreciation, the total depreciation up to the end of the 8th year and
the book value at the end of 8 years for an asset that costs ₱ 15,000 new and has an
estimated scrap value of ₱2,000 at the end of 10 year by (a) the declining balance method
and (b) the double declining balance method

Given: Co = ₱ 15,000, CL = ₱2,000, n = 8, L = 10

Required: the rate of depreciation k, total depreciation D 8 and book value C8

(a) declining balance method
(b) double declining balance method
Solution:

(a) Declining balance method

₱ ,
k = 1− = 1− = 0.1825 or 18.25%
₱ ,

C8 = Co (1 – k ) 8 = ₱ 15,000 ( 1 – 0.1825)8 = ₱ 2,992.22

D8 = Co - C8 = ₱ 15,000 - ₱ 2,992.22 = ₱ 12,007.78

(b) Double declining balance method

k = = = 0.20 or 20%

C8 = Co (1 - ) n = ₱ 15,000 (1 - )8 = ₱ 2,516.58

D8 = Co - C8 = ₱ 15,000 - ₱ 2,516.58 = ₱ 12,483.42

 5. The Sum - of - the - Years'- Digit (SYD) Method

Let dn = depreciation charge during the nth year

dn = (depreciation factor)(total depreciation)

dn = (Co - CL ) Eq. 27

For example, for a property whose life is 5 years

Year in Depreciation Depreciation

Year
Reverse Order Factor during the year

1 5 5/15 (5/15)( Co - CL)

2 4 4/15 (4/15)( Co - CL)
3 3 3/15 (3/15)( Co - CL)
4 2 2/15 (2/15)( Co - CL)
5 1 1/15 (1/15)( Co - CL)
Σ of digits = 15

Example 17

A structure costs ₱ 12,000 new. It is estimated to have a life of 5 years with a salvage
value at the end of life ₱1,000. Determine the book value at the end of each year of life.

Given: Co = ₱ 12,000, CL = ₱1,000, L = 5

Required: book value C5 using SYD

Solution:

Using SYD method

Co - CL = ₱ 12,000 - ₱1,000 = ₱11,000

Year in Depreciation Book value

Depreciation
Year Reverse during the at end of
Factor
Order year year

1 5 5/15 (5/15)( ₱11,000) = ₱ 3,666.67 ₱ 8,333.33

2 4 4/15 (4/15)( ₱11,000) = 2,933.33 5,400.00
3 3 3/15 (3/15)( ₱11,000) = 2,200.00 3,200.00
4 2 2/15 (2/15)( ₱11,000) = 1,466.67 1,733.33
5 1 1/15 (1/15)( ₱11,000) = 733.33 1,000.00
Σ of digits = 15

6. The Service-Output Method

This method assumes that the total depreciation that has taken place is directly
proportional to the quality of output of the property up to that time. This method has the
advantage of making the unit cost of depreciation constant and giving low depreciation
expenses during periods of low production.

Let T = total units of output up to the end of life

Qn = total number of units of output during the nth year

Depreciation per unit of output =

dn = (Q ) Eq. 28

Example 18

A Television Company purchased machinery for ₱ 100,000 on July 1, 2015. It is estimated

that it will have a useful life of 10 years; scrap value of ₱ 4,000, production of 400,000
units and working hours of 120,000.

The company uses the machinery for 14,000 hours in 2015 and 18,000 hours in 2016. The
machinery produces 36,000 units in 2015 and 44,000 units in 2016. Compute the
depreciation for 2016, using each method (a) Straight line, (b) Working hours , and (c)
Output method.

Given: Since 2016 is only required, thus:

Co = ₱ 100,000 T = 400,000 units L = 10
CL = ₱ 4,000 Hwh = 120,000 hours Hhu = 18,000
Q = 44,000

Required depreciation, d (2016) using:

a. straight line method
b. Working Hours
c. Output method

Solution:

a. Straight line method

₱ , ₱ ,
d = = = ₱ 9,600
b. Working Hours.

Let Hwh = Working hours

Hhu = Hours used

₱ , ₱ ,
d = Hhu = (18,000) = ₱ 14,400
,

c. Output method

₱ , ₱ ,
d = Q = (44,000) = ₱ 10,560
,
What Depreciation Method Should Be Used?

It is worth mentioning what the National Internal Revenue Code says about depreciation
specifically Section 29 (f).

(1) General Rule. "There shall be allowed as a depreciation deduction a reasonable

allowance for the exhaustion, wear and tear (including reasonable allowance for
obsolescence) of property used in the trade or business"
(2) Use of certain methods and rates. The term "reasonable allowance" as used in the
preceding paragraph shall include (but not limited to) an allowance computed in
accordance with the regulations prescribed by the Secretary of Finance, under any of
the following methods:
a. The straight line method;
b. Declining balance method, using a rate not exceeding twice the rate which
would have been used had the annual allowance been computed under the
method describe in paragraph (f)(1)
c. The sum-of-years-digits method, and
d. Any other method which may be prescribed by the Secretary of Finance upon
recommendation of the Commissioner of Internal Revenue.

Notes: Taxpayer may enter into "agreement in writing specifically dealing with the useful
life and rate of depreciation of any property, the rate so agreed upon shall be biding."

Example 19

A machine ₱ 7,000 costs, last 8 years and has a salvage value at the end of life ₱ 350.
Determine the depreciation charge during the 4th year and the book value at the end of 4
years by the (a) straight line method; (b) declining balance method; (c) SYD method; and
(d) sinking fund method with interest at 12%.

Given: Co = ₱ 7000 CL = ₱ 350 L = 8 n = 4 i = 12%

Required depreciation, d4 and book value, C4 using:

a. straight line method
b. declining balance method
c. SYD method
d. sinking fund method

Solution:

a. Straight line method

₱ , ₱
d = = = ₱ 831.25
( ) (₱ , ₱ )
D4 = = = ₱ 3,325.00

C4 = Co - D4 = ₱ 7,000 - ₱ 3,325 = ₱ 3,675.00

b. Declining balance method.

₱
k = 1− = 1− = 0.3123
₱ ,

D4 = Co (1 – k ) n-1 k = ₱ 7,000 (1 –0.3123 ) 3 (0.3123) = ₱ 710.99

C4 = Co (1 – k ) n = ₱ 7,000 ( 1 – 0.3123)4 = ₱ 1,565.65

c. SYD method.

( )
Sum of digits = = 36

d4 = (₱ 7,000 − ₱ 350 ) = ₱ 923.61

D4 = (₱ 7,000 − ₱ 350 ) = ₱ 4,802.78

C4 = Co - D4 = ₱ 7,000 - ₱ 4,802.78 = ₱ 2,197.22

d. Sinking fund method

₱ , ₱ ₱ , ₱
d = = =
/ , %, / , %, ( . )
.
₱ ,
=
.
= ₱ 540.66

D4 = d (F/A, 12%, 4)
4
(1+0.12) − 1
= (₱540.66)
0.12
D4 = ₱ 2,583.99

C8 = C o - Dn

= ₱ 7,000 - ₱ 2,583.99

C8 = ₱ 4,416.01
Example 20

A machine costs ₱ 20,000 and has a salvage value of ₱ 2,000 after a useful life of 8
years. Money is worth 12%. If average inflation is 8% per year during this period, what is
the annual cost of depreciation to replace the machine after 8 years? What is the annual
cost of depreciation if inflation is not considered?

Given: C0 = ₱ 20,000
CL = ₱ 2,000
L = 8
i = 12%
f = 8%

Required depreciation, d
a. with inflation
b. without inflation

Solution:

a. With inflation
₱ 37,018.60

0 1 2 3 8

d d d d

Future Cost = Present Cost (1 + f)n

Transforming the Equation into depreciation cost

Let Future Cost = D8 ; Present Cost = Co ; n = L

D8 = Co(1 + f)L - CL

D8 = ₱ 20,000 (1 + 0.08)8 - ₱ 2,000 = ₱ 35,018.60

Hence:

Dn = d (F/A, i %, L)

₱ , .
d = = = ₱ 2,847.11
/ , %, ( . )
.
b. Without inflation.

₱ 18,000

0 1 2 3 8

d d d d

₱ , ₱ ,
d = = = ₱ 1,463.45
/ , %, ( . )
.

VALUATION

Valuation or appraisal is the process of determining the value of certain property for
specific reasons. The person engaged in the task of valuation is called appraiser.

Appraised Value = (original cost + other expenses) – depreciation for a given nth
period + salvage value at the end of it life + intangible values

Intangible Values

In the determination of the value of industrial property or equipment, four intangible items
are often encountered.

1. Goodwill is that element of value which a business has earned through the favorable
consideration and patronage of its customers arising from its well-known and well
conducted policies and operation.

2. Franchise is an intangible item of value arising from the exclusive right of a company to
provide a specific product or service in a stated region of the country.

3. Going value is an intangible value which an actually operating concern has due to its
operation.

4. Organization cost is the amount of money spent in organizing a business and

arranging for its financing and building.

PROBLEM SET 2:

1. A machine shop purchased 10 years ago a milling machine for ₱ 60,000. A straight-line
depreciation reserve had been provided on a 20 year life of the machine. The owner of
the machine shop desires to replace the old milling machine with a modern unit of
many advantages costing ₱100,000. It can sell the old units for ₱ 20,000. How much
new capital will be required for the purchase?

2. A tax and duty free importation of a 30 HP sandmill (for paint manufacturing) cost
₱360,000. CFI Manila Bank charges arrastre and brokerage cost ₱5,000. Foundation
 and installation costs were ₱25,000. Other incidental expenses amount to ₱20,000.
Salvage value of the mill is estimated to be ₱60,000 after 20 years. Find the appraisal
value of the mill, using straight line depreciation, at the end of (a) 10 years and (b) 20
years. .

3. On January 1, 2015, the purchasing engineer of the Cement Co. purchased a new
machine at a cost of ₱140,000. Depreciation has been computed by the straight line
method based on an estimated useful life of five years and residual scrap value of
₱12,800. On January 2, 2018, extraordinary repairs (which were almost equivalent to a
rebuilding of the machinery) were performed at a cost of ₱ 30,400. Because of the
thorough going nature of these repairs, the normal life of the machinery was extended
materially. The revised estimate of useful life was four years from January 1, 2018.
(a) Determine the annual provision for depreciation for the years 2015 to 2018 and
the adjusted provision for depreciation on December 31, 2018. Assume
payment in cash for the machine and extraordinary repairs.

4. Power to a remote transmitting station is provided by a diesel-electric-generator unit.

The original cost of he unit is ₱65,000. It costs ₱2,000 to ship the unit to the job site.
An additional cost of ₱3,000 was incurred for installation.
(a) Determine the annual depreciation cost by the straight line method, If the unit
has an expected life of 10 years. The salvage value of the unit at the end of its
life was estimated at ₱5,000.
(b) Determine the annual depreciation unit cost by the sinking fund method.
Assume that the annual charge for depreciation was deposited in a fund drawing
compound interest at the rate of 5%.

5. An industrial plant bought a generator set for ₱90,000. Other expenses including
installation amounted to ₱10,000. The generator set is to have a life of 17 years with a
salvage value at the end of life of ₱5,000. Determine the depreciation charge during
the 13th year and the book value at the end of 13 years by the (a) declining balance
method, (b) double declining balance method, (c) sinking fund method at 12% and (d)
SYD method.

6. A Globe company purchased a microwave radio equipment for ₱6,000,000. Freight an

installment charges amounted to 3% of the purchase price. If the equipment shall be
depreciated over a period of 8 years with a salvage value of 5%, determine the
following:
(a) Annual depreciation charge using the straight line method
(b) Depreciation charge during the fifth year using the sum-of-the-years-digit
method.

Feedback

Did you find the problem sets easy? Well it is much easier if you follow the step solution
which consist of the given, required and solution. The solution if possible must present the
cash flow analysis because it aids in solving the problem. Try solving constantly problems
from other references given.
Summary

A deferred annuity is one where the first payment is made several periods after the
beginning of the annuity. An annuity due is one where the payment are made at the
beginning of each period. Perpetuity is an annuity in which the payments continue
indefinitely.

The capitalized cost of any property is the sum of the first cost and the present worth of all
costs of replacement, operation and maintenance for a long time or forever. There are
three conditions to solve the capitalized cost that the institution must look into. These are
as follows:
(a) No replacement, only maintenance and or operation every period,
(b) Replacement only, no maintenance and or operation, and
(c) Replacement , maintenance and or operation every period

Amortization is any method of repaying a debt, the principal and interest included, usually
by a series of equal payments at equal interval of time. In certain cases, uniform arithmetic
gradient. is used in the economic analysis problems that involve receipts or disbursements
that increase or decrease by a uniform amount for each period.

Depreciation is the decrease in the value of physical property with the passage of time.
There are six (6) can be used in solving the depreciation and book value of any acquired
assets of the institution such as machinery and equipment for a even period of its life
value. These are as follows:
(a) Straight line method
(b) Sinking Fund method
(c) Declining Balance method
(d) Double Declining Balance method
(e) Sum-of- the-Years'- Digit (SYD) method
(f) Service-Output Method

Valuation or appraisal is the process of determining the value of certain property for
specific reasons.

Suggested Readings

National Internal Revenue Code

Department of Agriculture Memorandum Order 61 s. 2020

Posttest

Direction: Choose the letter of the correct answer. Do not write your answer on this
manual.

1. All are requirements of depreciation except:

a. It should be simple.
b. It should recover capita.
c. The book value will be reasonably close to the market value at any time
d. The method should be accepted by the department of finance.
2. A depreciation value is directly proportional to the age of property.
a. straight line b. sinking fund c. declining balance d. double declining
3. It is determine by a disinterested party in order to establish a price that both seller and
buyer agreed.
a. value b. book value c. fair value d. scrap value
4. A construction firm applies a loan program from a bank amounting to ₱50,000 at
monthly interest rate of 3% diminishing for 12 months. What would be the monthly
payment of the firm on the 11th month.
a. ₱ 4,541.57 b. ₱ 4,791.67 c. ₱ 4,416.67 d. ₱ 4,291.67
5. An asset is purchased for ₱ 9,000. Its estimated economic life is 10 years after which it
will be sold for ₱ 1,000. Find the depreciation in the first three years using sum-of-
years digit method.
a. ₱ 2,972.38 b. ₱ 3,927.27 c. ₱ 1,163.64 d. ₱ 1,454.54 p 237
6. The equipment costs ₱ 10,000 with a salvage value of ₱ 500 at the end of 10 years.
Calculate the annual depreciation cost by sinking fund method at 4% interest.
a. ₱ 950.00 b. ₱ 791.26 c. ₱ 1,791.62 d. ₱ 256.71 p 235

For items 7-10: A machine costs ₱ 20,000, last 8 years and has a salvage value at the end
of life of 7%.of the original price.
Determine the book value at the end of 4 years:
7. Using Straight line method
a. ₱ 2,325 b. ₱ 9,300 c. ₱ 10,700 d. ₱ 3,676
8. Using Declining balance method
a. ₱ 2,828 b. ₱ 5,292 c. ₱ 2,086 d. ₱ 3,486
9. Using Sum of years digit method
a. ₱ 2,583 b. ₱ 13,433 c. ₱ 6,567 d. ₱ 2,197
10. Using Sinking Fund method
a. ₱ 2,583 b. ₱ 12,776 c. ₱ 7,224 d. ₱ 1,512

REFERENCES:

Besa Villa, V.I. Engineering Economy Revised Edition. VB Publisher. Copyright 1989.
Hartman, J.C., Engineering Economy and Decision-Making Process. Prentice-Hall
Pearson. 2007
Sta Maria, Hipolito B., Engineering Economy, Second Edition, National Bookstore, 1993
Sullivan, William G; Wicks, Elin M; Koeling , Patrick; Engineering Economy 16th Edition,
Pearson Publishing, 2013
http://www.csun.edu/~ghe59995/docs/Glossary%20of%20Concepts%20&%20Terms%20i
n%20Engineering%20Economy.pdf
https://www.profitbooks.net/what-is-depreciation
https://www.slideshare.net/ltpham18/lecture-4-gradients-factors-and-nominal-and-
effective-interest-rates