Agricultural Engineering Board Review Materials

Farm Economics

Prepared by

Ramon A. Razal, Ph.D.

Professor and Dean
College of Forestry and Natural Resources
University of the Philippines Los Baños
College, Laguna 4031

May 2004
(Reproduction with Permission Only)
PSAE Region IV – Agricultural Engineering Board Review Materials III - 1

Farm Economics
Ramon A. Razal
Professor and Dean
College of Forestry and Natural Resources
University of the Philippines Los Baños
College, Laguna 4031

I. Introduction

 Farm Economics/Agricultural Economics is concerned with the farmer as a member of

society. It deals with the farms as a group and determines the principles governing
not only the farm business but also the general welfare on a national and
international level.

 Agricultural engineers are usually confronted with situations in which they have to decide
on the probable effects of a new farm project. The agricultural engineer must
undertake economic studies that would indicate the relative profitability of the
proposed project to the private investor or the farmer and the benefits that will
accrue to society as a whole.

 The engineer must make a choice among several potential projects in view of the limited
availability of resources at a given time. By properly choosing the project, the
engineer is able to help maximize the economic returns from scarce economic
resources.

 Farm Economics provides the engineers with the tools such as the present value of net
benefits, discounted benefit to cost ratio, and internal rate of return that are used as
investment criteria for selection among several farm projects under consideration.

II. Theories, Concepts, and Application of Economics to Agricultural

Engineering

 Economic and Cost Concepts

First Cost vs Operation and Maintenance Cost

 First cost (also known as initial cost, investment cost) is the cost of getting an activity
started. Ordinarily occurs only once for any given activity.
Example: cost of land and design and construction cost of a factory building

 Operation and maintenance costs are costs experienced continually over the useful life
of an investment project or venture; contains most of the recurring costs associated with
operating a business or project.
Examples: wages, materials, cost of power

Fixed vs Variable Cost

 Fixed costs are those that are unaffected by changes in activity level over a feasible range
of operations for the capacity available. Example: cost of a machine, interest on borrowed
capital

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 Variable costs are those associated with an operation that will vary in total with the
quantity of output. Example: cost of materials, labor, fuel consumption

Total cost, CT

C
o Total variable cost, CV
s
t

Total Fixed Cost, CF

Production

Direct vs. Indirect or Overhead Costs

 Direct costs are those that can be reasonably measured and allocated to a specific output
or work activity.
Example: cement needed to make hollow blocks, amount of fertilizer applied per hectare
of farm planted to rice, volume of coconut oil needed to make bar soap

 Indirect costs (other terms are overhead cost or burden) are those that are difficult to
attribute or allocate to a specific output or work activity.
Example: cost of electricity needed to provide lighting to a factory; depreciation cost of
equipment used to fabricate a certain part of a product

Other Cost Terminology:

 Sunk cost – it is one that has occurred in the past and has no relevance to estimates of
future costs and revenues related to an alternative course of action. Example: In deciding
whether one should replace an old machine with a new one, the purchase cost of the old
machine is generally treated as a sunk cost

 Opportunity cost – is the cost of the best rejected (foregone) opportunity and is often
hidden or implied.

Price, Demand and Total Revenue

The relationship between selling price (p) and demand (D) for a product can be expressed as a
linear function:

p = a – bD

where: a = intercept on the price (y) axis

b = slope; it is the amount by which demand
increases for each unit decrease in p

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The total revenue, TR, is the product of the selling price per unit, p, and the number of units
sold, D. Thus,

TR = price × demand = p × D

The demand, Ď, that will maximize total revenue, is given by:

Ď = a/2b

Cost, Volume and Breakeven Point Relationships

At any demand, D, total cost CT is

CT = CF + CV
where: CF = total fixed cost
CV = total variable cost

If cv is the variable cost per unit, then the total variable cost will be
Cv = cv × D

where: D is the total product produced or volume demanded.

For any volume or demand, D

Profit () or Loss = Total Revenue – Total Costs

= -CF + (a – cv)  D – bD2

The value of D* that will maximize profit,

D* = a-cv
2b

Breakeven occurs when total revenue equals total cost:

At breakeven,
total revenue = total cost

Finding the roots, D’1 and D’2,

 (a  c v )  (a  c v ) 2  4(b)(C F )
D' 
2( b )

 Present economy studies

These are cost analyses undertaken when the influence of time on money is not a significant
consideration. Other authors refer to these as problems involving design for economy of
operations.

Situations involving present economy studies:

1) There is no initial investment of capital; only immediate operating costs and other factors are
involved.
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2) There is an initial investment of capital, but after this first cost the remaining life-cycle cost is
estimated to be the same, or directly proportional to the initial investment.
3) The difference in revenues and costs among the alternatives occur within a limited time
period (1 year or less), or any future differences are estimated to remain proportional to
those in the first time period. This is often the case when the decision is between alternative
materials in engineering/manufacturing.

In engineering practice, the following are some of the situations that can be analyzed as present
economy studies:
a) Material selection
b) Make versus purchase studies
c) Alternative machine speeds

 INTEREST FORMULAS AND EQUIVALENCE

(The relationship between time and money)

 Interest
Interest is a fee that is charged for the use of someone else’s money. The
percentage of money charged as interest is called interest rate.

 Simple Interest
Simple interest is defined as a fixed percentage of the principal (initial amount
of loan or money borrowed) multiplied by the life of the loan (or the number of interest
periods for which the principal is committed).

Total interest, I, is computed by the formula:

I = (P) ´ (n) ´ (ì)

where: P = principal
n = number of interest period (for example, years)
ì = interest rate per interest period (expressed as a decimal)

 Compound Interest
Whenever the interest charge for any interest period is based on the remaining principal
amount plus any accumulated interest charges up to the beginning of that period, the
interest is said to be compound.

In general, if there are n interest periods,

Fn = P (1 + ì)n

Where: Fn is the total amount of money accumulated or owed after n interest periods.

 CASH FLOW DIAGRAM AND INTEREST FORMULAS

 Notations used in formulas for compound interest calculations:

i = interest rate per interest period

n = number of compounding periods
P = present sum of money; the equivalent worth of one or more cash flows at a
reference point in time called the present
F = future sum of money; the equivalent worth of one or more cash flows at a reference
point in time called the future

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A = end-of-period cash flows in a uniform series continuing for a specified number of

periods; starting  at the end of the first period and continuing through the last period.

 Cash flow diagram:

A cash flow is the difference between total cash receipts (inflows) and total cash disbursements
(outflows) expenditures for a given period of time.

A cash flow diagram is used to visualize a  cash  flow; individual  cash  flows are presented
as vertical arrows along a horizontal time scale. “Upward-pointing“arrows are used to
represent positive cash flows (net inflows) while “downward-pointing” arrows show negative
“cash flows” (net outflows). The length of an arrow is proportional to the magnitude of the
corresponding cash flow. Each cash flow is assumed to occur at the end of the respective
time period. The cash flow diagram is dependent on the point on view (e.g. lender versus
borrower viewpoint).

 The Concept of Time Value of Money

It is often said that money makes money. This is true because if we invest money today
(for example deposit it in a bank, or design a product, machine or structure that will sell at a
value more than what it costs), by tomorrow we will have accumulated more money than
what we had originally invested. This change in the amount of money over a given time
period is called the time value of money. This also explains why, if you borrow money
today you will have to pay in the future an amount that is larger than what you have
originally owed.

 The Concept of Equivalence

The time value of money and interest rate utilized together generates the concept of
equivalence. Equivalence means that different sums of money at different times can be
equal in economic value.

Economic equivalence is established, in general, when we are indifferent between a

future payment, or series of future payments, and a present sum of money. Given a set of
financial plans or alternatives, equivalence is established when total interest paid, divided by
peso-years (or dollar-years) of borrowing, is a constant ratio among the financing plans.

 INTEREST FORMULAS FOR DISCRETE CASH FLOWS INVOLVING ANNUAL

COMPOUNDING AND THEIR APPLICATIONS

Discrete    compounding means that the interest   is compounded at the end of each finite
length period, such as a month or a year. The formulas also assume discrete (lump-sum)
cash flows spaced at the end of equal time intervals of a cash flow diagram. Discrete
compounding interest factors are given in Appendices of most Engineering Economy
textbooks.

 Single payment, compound amount factor:

It is used to find F when given P

- It is used to solve engineering economy problems that can be represented by the
following cash flow diagrams:

P F=?
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F=?

0 n or 0 n

It is given by the expression:

F = P(1 + i)n = P × (F/P, i, n)

 Single payment, present worth factor:

It is used to find P when given F

- It is used to solve engineering economy problems that can be represented by the
following cash flow diagrams:

P=? F
F

0 n or 0 n

P=?

It is the reciprocal of the compound amount factor and is given by

P = F(1 + i)-n = F × (P/F, i, n)

UNIFORM SERIES

Uniform   series  means  uniform  amount  of  money, A, occurring at the end of each period
for n periods with interest  at  i% per period. A uniform series is  often called annuity.

Other assumptions:
a) P (present worth) occurs at 1 interest period  before the first A.
b) F (future worth) occurs at the same time as the last and n interest periods after P.
c) A (annual worth) occurs at the end of periods 1 through N, inclusive.

 Uniform series, compound amount factor:

It is used to find F when given A

It is given by

F = A × [(1 + i)n - 1] = A × (F/A, i%, n)

i

 Uniform series, present worth factor:

It is used to find P when given A

It is given by

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( 1 + i) n 1
P=A× = A × (P / A , i%, n)
i(1 + i)n

 Uniform series, sinking fund factor:

It is used to find A when given F

It is the reciprocal of the uniform series compound amount factor and is given by
i
A =F × = F × (A/F, i%, n)
(1 + i)n - 1

 Uniform series, capital recovery factor:

It is used to find A when given P

It is the reciprocal of the uniform series present worth factor and is given by

i (1 + i)n
A =P× = P (A/P, i%, n)
(1 + i)n - 1

 Nominal and Effective Rates

For example, if the interest rate is 6% per interest period and the interest
period is 6 months, it is customary to speak of this rate as “12% compounded semiannually”.
In this case, 12% is the nominal interest rate r per year or the basic annual interest rate.

Effective annual rate, ia, is the actual or exact rate of interest earned on the
principal during one year. Note that it is expressed on an annual basis.

The relationship between effective annual interest, i a, and nominal interest r, is

ia = (1 + r/M)M - 1

where: M is the number of compounding periods per year and r is expressed in decimal

 Interest problems with cash flows involving more frequent compounding

Case I. Compounding and payment periods coincide.

This is easy to evaluate because the interest factors can be used directly.

Case II. Compounding more frequent than payments.

There are 2 approaches to evaluate this type of problem:

1) The payments can be expressed such that they will be made to coincide with the
frequency of compounding; or

2) An effective rate that coincides with the frequency of payment is first calculated. In
general, if ì is the effective interest rate per interest period and there is a uniform
cash flow, X, at the end of each kth interest period (k>1), then the equivalent
payment, A, at the end of each interest period is

A = X(A/F, i%, k)

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Case III. Compounding less frequent than payments.

Table 2. Various interest statements and their interpretation.

Interest rate statement Interpretation Comment

i = 12% per year i = effective 12% per year
compounded yearly
i = 1% per month i = effective 1% per month
compounded monthly
i = 3½% per quarter i = effective 3½% per
quarter compounded
quarterly
i = 8% per year, i = nominal 8% per year
compounded monthly compounded monthly
i = 4% per quarter i = nominal 4% per quarter
compounded monthly compounded monthly
i = 14% per year i = nominal 14% per year
compounded compounded
semiannually semiannually
i = effective 10% per year i = effective 10% per year
compounded monthly compounded monthly
i = effective 6% per i = effective 6% per quarter
quarter compounded quarterly
i = effective 1% per month i = effective 1% per month
compounded daily compounded daily
When no compounding period
is given, interest
rate is an effective rate,
with compounding period
assumed to be equal to
stated time period.
When compounding period is
given without stating
whether the interest rate is
nominal or effective,
it is assumed to be
nominal. Compounding
period is as stated.
If interest rate is stated as an
effective rate, then it is an
effective rate. If
compounding period is
not given, compounding
period is assumed to
coincide with stated time
period.

Source: Blank and Tarquin. 1989. Engineering Economy (3rd ed.). McGraw-Hill
International.

 Methods for evaluating the economic profitability of a single proposed problem

solution or alternative

 Present Worth Method (or Net Present Value, NPV)

- Based on the concept of equivalent worth of all cash flows relative to some base or
beginning point in time called the present.

- To find the PW as a function of i% of a series of cash receipts and/or expenses, use the
following relationship:

PW (i%) = Fo (1 + i)0 + F1 (1+ i)-1 + F2 (1+ i)-2 + ... +Fk (1 + i)-k + ... + FN(1 + i)-N
N
PW (i%) =  Fk (1 + i)-k
k=0

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where i = effective interest rate, or MARR, per compounding period

k = index for each compounding period (0 < k < N)
Fk = future cash flow at the end of period k
N = number of compounding periods in the planning horizon

Criterion: A project is acceptable if PW > 0.

 Future Worth Method

- All cash inflows and outflows are compounded forward to a reference point in time called
the future.

- To determine the future worth of a project, the following relationship is used:

FW (i%) = F0(1+ i)N + F1(1 + i)N-1 + ... + FN(1 + i)0

N
FW (i%) =  Fk (1 + i)N-k
k=0
Criterion: A project is acceptable if FW > 0.

 Annual Worth Method

- The AW is the annual equivalent revenues (or savings), R, minus annual equivalent
expenses, E, less its annual equivalent capital recovery cost, CR.

- AW is calculated as follows:
AW (i%) = R - E - CR (i%)
- CR is computed with i = MARR using the following:
CR (i%) = I (A/P, i%, N) - S (A/P, i%, N)

where I = initial investment for the project

S = salvage (residual) value at the end of the study period
N = project study period.

Criterion: A project is acceptable if AW > 0.

 Internal Rate of Return Method

- It is the most widely used method, and is also known as investor's method, discounted cash
flow method, and profitability index.

- This involves solving for the interest rate, termed internal rate of return ( IRR), that
equates the equivalent worth of cash inflows (receipts or savings) to the equivalent worth
of cash outflows (expenditures, including investments).

- By using a PW formulation, IRR is the i'% at which

N N
 Rk (P/F, i'%, k) =  Ek (P/F, i'% , k)
k=0 k=0
where R = net revenues or savings for the kth year
E = net expenditures including investments for the kth year
N = project life (or study period)

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Criterion: A project is acceptable if i' > MARR.

 Benefit/Cost Ratio Method

- This is also known as savings-investment ratio (SIR).

- Two commonly used formulations of the B/C ratio (expressed in terms of AW):

1) B/C = AW (benefits of the proposed project)

AW (total cost of the proposed project)

= B .
CR + (0 & M)
where AW = annual worth
B = annual equivalent worth of benefits of the proposed project
CR = capital recovery cost
O & M = equivalent annual operating and maintenance expenses of the proposed project
2) Modified B/C ratio:

B/C = B - (O & M)
CR

The numerator expresses the equivalent worth of the benefits minus the equivalent annual
operating and maintenance costs.

The denominator includes only the annual equivalent investment costs.

Criterion: A project is acceptable when the B/C ratio is greater than or equal to 1.0.

 COMPARING ALTERNATIVES

 Alternatives are called mutually exclusive when the selection of one feasible method or
alternative excludes the consideration of any other alternative.

 An engineering economy study must be performed to determine which one to choose

among mutually exclusive alternatives and how much capital to invest because different
levels of investment produce varying economic outcomes.

 As a policy, “The alternative that requires the minimum investment of capital and
produces satisfactory functional results will be chosen among mutually exclusive
alternatives unless the incremental capital associated with an alternative having a larger
investment can be justified with respect to its incremental savings (or benefits).

 The base alternative is the alternative that requires the least investment of capital and
that has a return equal to or greater than the MARR.

 The investment of additional capital over the base alternative should be made if the extra
benefits, for example, increased capacity, increased quality, increased revenues,
decreased operating expenses, or increased life are better than those that could be
obtained from investment of the same capital elsewhere.

 Investment alternatives are those with initial or (front-end) capital investment(s) that
produce cash flows from increased revenue, savings through reduced costs, or both.

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 Cost alternatives are those with all negative cash flow elements except for a possible
positive cash flow element from disposal of assets at the end of the project’s life.

 Incremental Investment Analyses

i) With the lower initial cost alternative as base alternative, i.e. as alternative (A) tabulate
cash flow for both alternative in the order of increasing initial investment.

ii) Calculate the difference, (B-A) (or incremental net cash flow A  B, where the arrow
means the increment between Alternative A and B).

iii) Draw an incremental net cash flow diagram.

iv) Determine the internal rate of return of the incremental cash flow, IRR .
v) If IRR A  B is greater than the MARR, then the incremental investment is justified and
select B, otherwise, select A.

 Comparing Alternatives With Unequal Lives

When alternatives have unequal lives, a procedure that will put the alternatives on a
comparable basis must be adopted before making an engineering economy study. To do
this, two assumptions regarding the study period can be employed.

i) Repeatability assumption. This involves 2 conditions:

1) Study period over which the alternatives are compared is either indefinitely long or equal
to a common multiple of the lives of the alternatives (Use least common multiple for
present worth comparisons).
2) Economic consequences that are estimated to happen in an alternative’s life span will
also happen in all succeeding life spans, if any.

ii) Coterminated assumption. It uses a selected study period for all alternatives, with
appropriate assumptions and adjustments to put alternatives on a common and
comparable basis.

 The incremental investment analysis procedure for comparing more than two
mutually exclusive alternatives.

i) Arrange (order) the alternatives based on increasing initial investment cost.

ii) Establish a base alternative

a) Cost alternatives - The first alternative (least initial investment cost is the base).
b) Investment alternatives - If the selection criterion value for first alternative is
acceptable, select it as the base; otherwise, select the next alternative in the
arranged order. Continue until an acceptable criterion value is obtained.
iii) Use iteration to evaluate differences between alternatives until no more alternatives exist.

a) If the criterion value for the incremental cash flow between the next alternative and the
current best alternative is favorable, choose the next alternative as the current best
alternative. Otherwise, retain the last alternative with an acceptable criterion value as
the current best alternative.
b) Repeat, and select as the preferred alternative the last one for which the incremental
cash flow criterion value was acceptable.

 Comparison of Alternatives Using the Capitalized Worth Method.

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The capitalized worth of a project is the present worth or value of a project that is
assumed to last forever. If expenses only are considered, results obtained are
appropriately expressed as capitalized cost.
The capitalized worth method is a convenient basis for comparing mutually exclusive
alternatives when the period of needed service is indefinitely long or when the common
multiple of the lives if very long and the repeatability assumption is applicable.
Thus, given a perpetual annual uniform payment A, with interest at i% per period, the
capitalized worth is:

CW = P = A (P/A, i% , ).

As n becomes very large, (P/A, i%, n)1/i

Thus, CW = P = A ( 1/i)

w Depreciation and Taxation

 Depreciation - is the decrease in value of physical properties with the passage of time. It is
an accounting concept that establishes an annual deduction against before-tax income such
that the effect of use and time on an asset’s value can be reflected in a firm’s financial
statements. It is a non-cash cost that affects income taxes.

A physical asset has commercial value because of benefits in the form of future cash
flows resulting from (1) the use of the asset to produce saleable goods or services or (2) the
ultimate sale of the asset.

 Value is the present worth (PW) of all the future profits that are to be received through
ownership of a particular property.

 Market Value (MV) is what will be paid by a willing buyer to a willing seller for a property
where each has equal advantage and is under no compulsion to buy or sell.

 Salvage or residual value (SV) is the price that can be obtained from the sale of the
property after it has been used. It is the best estimate of an asset’s net market value at
the end of its useful life. If used in depreciation calculations, it is referred to as estimated
salvage (ES), representing an asset’s terminal value.

 Book value (BV) is the worth of a property as shown on the accounting records of a
company. Ordinarily, it means the original cost of the property less all amounts that have
been charged as depreciation expense.

 Basis (or cost basis) is the cost of acquiring an asset (purchase price) including normal
costs of making the asset serviceable. Also referred to as unadjusted cost.

 Adjusted (cost) basis refers to changes to the original cost basis of a property caused by
various types of improvements or casualty losses.

 Amortization is the distribution of the cost of certain types of property, usually intangible,
over a prescribed period of time that are usually made in equal installments.

 Tax life is the period of time over which depreciation deductions are used to off- set
taxable income in determining income taxes.

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 Useful life is the period of time as asset is kept in productive use in a trade or business.

A property is depreciable if it meets all 3 requirements as follows:

1) It must be used in business or held for the production of income.
2) It must have determinable life, and the life must be longer than 1 year.

3) It must be something that wears out, decays, gets used up, become obsolete, loses value
from natural causes.

 Gross Revenues (R). Total revenues from sale of goods plus income from dividends,
interest, rent, royalties, and gains on the exchange of capital assets.

 Gross Income (I). Total of all income from revenue-producing sources less all ordinary and
necessary operating expenses including cost of goods sold and interest.

 Operating Expenses (E). All costs incurred while transacting business, except capital
expenditures, tend to be proportional to the extent of business activity and include interest
paid for the use of borrowed capital.

 Income Taxes (T). Costs to an organization that depend on profits remaining after
expenses are paid or accounted for.

 Effective income tax rate (t). Rate used for computing income taxes.

 Taxable income or net income before taxes (NIBT), equal to gross income minus
expenses minus depreciation.

 Capital gain. A gain incurred when the selling price of property exceeds the purchase price.

 Capital loss is incurred if the selling price is less than the book value.

 Net Operating Loss (NOL) results when a corporation’s deductions and expenses exceed
its gross revenues.

 Recaptured depreciation (RD). If a depreciable property is sold for an amount greater

than the current book value, the excess is depreciation recaptured by the sale and must be
considered and taxed as ordinary taxable income.

 Types of Taxes

1. Income taxes are assessed as a function of gross revenues minus certain allowable
deductions and exemptions.

2. Property taxes are assessed as a function of the value of real estate, business, and
personal property. They are independent of the income or profit of an individual or a
business.

3. Sales taxes are assessed on the basis of purchases of goods and/or services, and are
independent of gross income or profits.

4. Excise taxes are taxes assessed as a function of the sale of certain goods or services
often considered non-necessities, also independent of the income or profit of
an individual or a business.

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 Depreciation Methods

 Straight-line Method

It assumes that a constant amount is depreciated each year over the useful life of the
asset. If

N = depreciable life of the asset in years

B = cost basis
dK = annual depreciation deduction in year k (1<k<N)
BVk = book value at the end of year k
ESN = estimated salvage value in year N
d*k = cumulative depreciation through year k

then dk = (B-ESN)/ N
d*k = kdk for 1 < k < N
Bvk = B - d*k

 Declining Balance Method (DBM)

It is sometimes called the constant percentage method or the Matheson formula and
assumes that the annual cost of depreciation is a fixed percentage of the BV at the
beginning of the year. The ratio, R, of the depreciation in any one year to the BV
at the beginning of the year is constant throughout the life of the asset. For example, R=
2/N when a 200% declining balance is used (i.e., twice the straight line rate of 1/N). The
following relationships hold for the DBM.

d1 = B(R)
dk = B(1 - R)k-1 (R)
d*k = B [1 - (1 - R)k]
BVk = B(1 - R)k
BVN = B(1 - R)N

 Sum of the Years Digits (SYD) Method

a) List the digits corresponding to the number for each permissible year of life in reverse
order.

b) Determine the sum of these digits.

c) For any year, the depreciation factor is the number from the reversed- order listing for
that year divided by the sum of the digits.

d) The depreciation deduction for any year is the products of the SYD depreciation factor
that year and the difference between the cost basis and the ESN.

In general, the annual cost of depreciation for any year k is:

dk = (B - ESN) *[2 (N - k + 1) ]
N (N + 1)

The book value at the end of year k is:

BVk= B - [2 (B - ESN) ] k + [ (B - ESN)] k (k + 1)

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N N (N + 1)

The cumulative depreciation through the kth year is:

d*k = B - BVk

 Sinking Fund Method

This method depreciates an asset as if the firm were to make a series of equal deposits
whose value at the end of the asset’s useful life just equaled the cost of replacing the asset.

If A’ = sinking fund deposit

C = purchase price of replacement asset - net salvage value of current asset
N = useful life of current asset
i = annual interest rate,

then A’ = C (A/F, i%, N)

The amount in the sinking fund at the end of year k (k = 1,2,...N) is the accumulated
depreciation through k, thus:

d*k = A’ (F/A, i%, k)

= C (A/F, i%, N)(F/A, i%, k)

The depreciation in year k, which includes interest earned at that time, is given as:
dk = dk - dk-1
= C (A/F, i%, N)[(F/A, i%, k) - (F/A, i%, k-1)]
= C (A/F, i%, N) (1 + i)k-1

The book value value, BV, as usual is defined as

Bvk = B - d*k

 The Service-Output Method

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

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

Qk = total units of output during the kth year

depreciation per unit of output = dT = B - S

T
dk = dT (Qk) = (B - S) (Qk)
T
 Basic Tax Formulas and Computations

Taxes are computed using the general relation

Taxes = Taxable income x tax rate

In symbols, this is:

Farm Economics
PSAE Region IV – Agricultural Engineering Board Review Materials III - 16

T = NIBT x (t)

Where:
NIBT = R - (E + d)
R = revenues
E = expenses
d = depreciation

To facilitate computation of after-tax profitability of an investment, a table using the

format below is recommended:

A B C=A-B D = -t * C E=A+D
End-of- Before tax Depreciation Taxable income Cash flow for After tax cash
year (EOY) cash taxes income flow
flow
k BTCFK DK NIBT TK ATCFK

The after-tax cash flow in column E can serve as the basis for evaluation, using the after-
tax MARR, by any of the methods previously learned for evaluating the profitability of an
alternative (i.e., PW, AW, FW methods, IRR, and B/C analysis).

IV. References

1) Arreola, M. 1993. Engineering Economy (3rd Ed.) Ken, Inc. Quezon City,
Philippines.
2) Blank, L.T. and A.J. Tarquin. 1989. Engineering Economy (3 rd Ed.) McGraw-Hill
Book Co., Singapore.
3) De Garmo, E.P., W.G. Sullivan, J.A. Bontadelli and E.M. Wicks. 1997. Engineering
Economy – International Edition (10th Ed.) Prentice-Hall International, London,
U.K.
4) Gittinger, J.P. 1982. Economic Analysis og Aricultural Projects. The Johns
Hopkins University Press, Baltimore, MD, USA.
5) Institute for Small Scale Industries. 1990. Project Study Preparation Course –
Compilation of Hand-outs. U.P. Diliman, Quezon City, Philippines.
6) International Rice Research Institute. 1985. Irrigation Water Management –
Compilation of Lecture Notes. Los Baños, Laguna.
7) Kurtz, M. Engineering Economics for Professional Engineers’ Examinations (2 nd
Ed.) McGraw Hill, Inc. USA.
8) LaLonde, W.S. Jr. and W.J. Stack-Staikidis. 1984. Professional Engineers’
Examination Questions and Answers (4th Ed.) McGraw-Hill Book Company, New
York, USA.
9) Sepulveda, J.A., W.E. Sounder and B.S. Gottfried. 1984. Theory and Problems of
Engineering Economics (Schaum’s Outline Series). McGraw-Hill, Inc., New York,
USA.
10) Smith, G.W. 1987. Engineering Economy – Analysis of Capital Expenditures (4 th
Ed.) Iowa State University Press, Ames, Iowa, USA.
11) Sta. Maria, Hipolito B. 1993. Engineering Economy (2nd Ed.) National Book Store,
Inc. Manila.
12) Thuesen, G.J. and W.J. Fabrycky. 1989. Engineering Economy (7 th Ed.) Prentice-
Hall International, London, UK.

Farm Economics