E - ENGINEERING ECONOMICS (LECTURE)

1. Engineering Economics
Engineering Economics – is the study of the cost factors involved in engineering projects, and using the
results of such study in employing the most efficient cost-saving techniques without affecting the safety and
soundness of the project
2. Definitions
Investment – is the sum total of first cost (fixed capital) and working capital which is being put up in a
project with the aim of getting a profit.
Fixed Capital – is a part of the investment which is required to acquire or set up the business.
Working Capital – is the amount of money set aside as part of the investment to keep the project or
business continuously operating.
Demand – is the quantity of a certain commodity that is bought at a certain price at a given place and time.
Supply – is the quantity of a certain commodity that is offered for sale at certain price at a given place.
Perfect Competition – is a business condition in which a product or service is supplied by a number of
vendors and there is no restriction against additional vendors entering the market.
Monopoly – is a business condition in which as unique product or service is available from only one supplier
and that supplier can prevent the entry of all others into the market.
Oligopoly – is a condition in which there are so few suppliers of a product or service that action by one will
almost result in similar action by the others.
Law of Supply and Demand - “Under conditions of perfect competition, the price of a product will be such
that supply and demand are equal.”
Law of Diminishing Returns – “When the use of one of the factors of production is limited, either in
increasing cost or by absolute quantity, a point will be reached beyond which an increase in the variable
factors will result in a less than proportionate increase output.”
3. Interest
Interest – is the money paid for the use of borrowed money.
4. Simple Interest
Simple interest – is the interest paid on the principal (money lent) only.
I = Pni
F = P + I = P + Pni = P (1 + ni )
Where:
F = future value
P = present value
n = number of interest period
i = interest rate per period
I = interest
Two Types of Simple Interest
4.1 Ordinary simple interest , 1 year = 360 days
4.2 Exact simple interest, 1 year = 365 or 366 days

E Page 1
 E - ENGINEERING ECONOMICS (LECTURE)

5. Compound Interest
Compound interest – is the interest which is calculated not only on the initial principal but also the
accumulated interest of prior periods.
F = P(1 + i )n
Single payment compound amount factor = (F P , i%, n ) = (1 + i )n
F = P(F P , i%, n )
Single payment present worth factor = (P F , i , n) = (1 + i )− n
P = F (P F , i%, n )
Where:
F = future value
P = present value
n = number of interest period
i = interest rate per period
6. Cash Flow Diagram
Cash flow diagram – is a graphical representation of cash flows drawn on a time scale.

7. Discount
Discount – is the difference between the future worth and the present worth of a unit.
Discount, D = F − P
F−P
Rate of discount, d =
F
8. Nominal and Effective Rate of Interest
Nominal interest rates – is the cost of borrowed money which specifies the rate of interest and the number
of interest periods.
Effective interest rates – is the actual rate of interest on the capital and is equal to the nominal rate if
compounded annually. Effective interest rate is greater than nominal interest rates.

Let in = nominal interest rate or annual percentage rate

m = number of sub periods per year
m
 in 
Effective interest rate = i = 1 +  −1
 m

E Page 2
 E - ENGINEERING ECONOMICS (LECTURE)

Where:
m = 2 for semi-annually
m = 4 for quarterly
m = 12 for monthly
m = 6 for bi-monthly
m = 360 for daily

9. Continuously Compounding Interest Rate

F = Pe rt
Where:
F = future value
P = principal or present value
r = continuously compounding interest rate
t = number of interest periods
10. Annuity
Annuity – is a series of equal payments occurring at equal intervals of time.

Amortization – is a payment of debt by installment usually by equal amounts and at equal intervals of time.

10.1 Applications of annuity

10.1.1 Installment purchase.
10.1.2 Amortization of loan.
10.1.3 Depreciation
10.1.4 Payment of insurance premiums.
10.2 Types of annuity
10.2.1 Ordinary Annuity – payments occur at the end of each period.
10.2.2 Annuity Due – payments occur at the beginning of each period.
10.2.3 Deferred Annuity – first payment occurs later than at the end of the first period.
10.2.4 Perpetuity – an annuity that continues indefinitely.

11. Ordinary Annuity

E Page 3
 E - ENGINEERING ECONOMICS (LECTURE)

Uniform series compound amount factor = (F A , i%, n ) =

(1 + i )n − 1
i
F = A(F A , i%, n )
i
Uniform series sinking fund factor = ( A F , i %, n ) =
(1 + i )n − 1
A = F ( A F , i%, n )

n
i (1 + i )
Capital recovery factor = ( A P , i %, n ) =
(1 + i )n − 1
A = P( A P , i%, n )

Uniform series present worth factor = (P A , i %, n ) =

(1 + i )n − 1
i (1 + i )n
P = A(P A , i%, n )

Where:
F = future value of the periodic payments at the end of n periods.
P = present value of the periodic payments
A = Annuity or periodic payments
n = number of periodic payments
i = interest rate per period

12. Annuity Due

P = A + A(P A ,i%,4)
F = P(F P ,i%,5)
F = P(1 + i )5

E Page 4
 E - ENGINEERING ECONOMICS (LECTURE)

13. Deferred Annuity

P = A(P A , i%,5)(P F , i%,3)

F = P(F P ,i%,8)
F = P(1 + i )8
14. Perpetuity
A
P=
i
Where:
P = present value of the perpetuity
A = Annuity or periodic payments
i = interest rate per period

15. Arithmetic Gradient

Arithmetic-gradient present worth factor = (P G , i%, n) =

(1 + i )n − 1 − n
i 2 (1 + i )n i (1 + i )n

Arithmetic-gradient future worth factor = (F G , i%, n) =

(1 + i )n − 1 − n
2
i i
1 n
Arithmetic-gradient uniform-series factor = ( A G , i%, n ) = −
i (1 + i )n − 1

E Page 5
 E - ENGINEERING ECONOMICS (LECTURE)

PG = G (P G , i%, n )
AG = G ( A G , i %, n )
FG = PG (F P , i%, n) = G (F G , i%, n )
Where:
AG = Equivalent annual amount of gradient series.

16. Geometric Gradient

   1 + g n 
 A1 1 −   
   1 + i  
Pg =  g ≠i
 i−g
 n
A1 g =i
 1+ i
Fg = Pg (F P , i %, n )

17. Depreciation
Depreciation – is the decrease in value of a physical property due to the passage of time. Depreciation of a
property is an example of capitalization.
17.1 Types of Depreciation
17.1.1 Physical depreciation – is a type of depreciation caused by the lessening of the physical
ability of the property to produce results, such as physical damage, wear and tear.

E Page 6
 E - ENGINEERING ECONOMICS (LECTURE)

17.1.2 Functional depreciation – is a type of depreciation caused by the lessening in the

demand for which the property is designed to render, such as obsolescence and
inadequacy.
17.2 Purposes of Depreciation
17.2.1 To provide for the recovery of capital invested in the property.
17.2.2 To enable the cost of depreciation to be charged to the cost of producing the products
turned out by the property.
17.3 Depreciation Terms
First Cost (FC) – is the total amount invested on the property until the property is put into
operation.
Economic Life (n) – is the length of time at which a property can be operated at a profit.
Valuation (Appraisal) – is the process of determining the value or worth of a physical property
for specific reasons.
Value – is the present worth of all the future profits that are to be received through ownership
of the property.

17.4 Classification of Values

Market value – is the price that 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.
Book value (BV) – is the worth of a property as shown in the accounting records of an
enterprise.
Salvage or resale value (SV) – is the price of a property when sold second-hand; also called
trade-in value.
Scrap value (SV) – is the price of a property when sold for junk.
Fair value – is the worth of a property as determined by a disinterested party which is fair to
both seller and buyer.
Use value – is the worth of property as an operating unit.
Face or par value (F) – is the amount that appears on the bond which is the price at which the
bond is first bought.
18. Methods of Computing Depreciation
18.1 Straight Line Method
Straight line method – is a method of computing depreciation in which the depreciation has the
same value each year.
FC − SV
Annual Depreciation = d =
n
Book Value for m years.
 FC − SV 
BV = FC − m 
 n 
Depreciation rate (d) – is the annual rate for reducing the value of a property using depreciation
method.

E Page 7
 E - ENGINEERING ECONOMICS (LECTURE)

Annual Depreciation
Depreciation rate =
First Cost

18.2 Sinking Fund Method

Sinking fund method – is a method of computing depreciation in which the initial depreciation is
low.
FC − SV FC − SV
Annual Depreciation = d = =
(F A , i%, n) (1 + i )n − 1
i
Where:
i = interest rate or worth of money
Book Value for m years.
 (1 + i )n − 1 
BV = FC − d  
 i 

18.3 Sum-of-the-Years-Digits (SOYD) Methods

SOYD – is a method of computing depreciation in which the digits from year 1 to year n are
added and the depreciation in a certain year decreases by a constant amount each year.
n(n + 1)
T = SOYD =
2
 n − k +1 
dk =  (FC − SV )
 T 
n
d1 =  (FC − SV )
T 
 n −1 
d2 =  (FC − SV )
 T 
n−2
d3 =  (FC − SV )
 T 
Etc.
Book Value for m years.
BV = FC − (d1 + d 2 + d 3 + L d m )
18.4 Declining Balance Method
(Also called Diminishing Balance Method, Matheson Method, Constant-Percentage or Constant
Ratio Method).
SV = FC (1 − r )n
d k = r (FC )(1 − r )k −1
d1 = r (FC )
d 2 = r (FC )(1 − r )
d 3 = r (FC )(1 − r )2

E Page 8
 E - ENGINEERING ECONOMICS (LECTURE)

Etc.
Book Value for m years.
BV = FC (1 − r )m

18.5 Double Declining Balance Method

Double declining balance method – is a method of computing depreciation in which the
depreciation of salvage and the book value never stops decreasing. Double declining balance is
dependent on accumulated depreciation.
L
 2
SV = FC 1 − 
 L
k −1

dk =
2
(FC )1 − 2 
L  L
2
d1 = (FC )
L

d2 =
2
(FC )1 − 2 
L  L
2
2  2
d 3 = (FC )1 − 
L  L
Etc.
Book Value for m years.
m
 2
BV = FC 1 − 
 L
18.6 Service Output or Production Units Method
Service output method – is a method of computing depreciation in which depreciation is
calculated based on the total production produced per year.
FC − SV
Depreciation per unit, d =
No. of units capacity

18.7 Working Hours or Machine Hours Method

FC − SV
Depreciation per hr, d =
No. of hours capacity

19. Depletion - is the decrease in value of property due to the gradual extraction of its contents, such as mining
properties, oil wells, timber lands and other consumable resources.
Two Methods of Depletion
19.1 Cost Depletion – is based on the level of activity or usage, not time, as in depreciation. It may be
applied to most types of natural resources.
Cost depletion factor for year t is the ratio of the first cost of the resource to the estimated
number of units recoverable.

E Page 9
 E - ENGINEERING ECONOMICS (LECTURE)

first cost
pt =
resource capacity
The annual depletion charge is pt times the year’s usage or volume. The total cost depletion
cannot exceed the first cost of the resource. If the capacity of the property is reestimated some
year in the future, a new cost depletion factor is determined based upon the undepleted
amount and the new capacity estimate.

19.2 Percentage Depletion – is a special consideration given for natural resources. A constant, stated
percentage of the resource’s gross income may be depleted each year provided it does not
exceed 50% of the company’s taxable income. For oil and gas property, the limit is 100% of
taxable income. The annual depletion amount is calculates as
Percentage depletion amount = percentage x gross income from property

Using percentage depletion, total depletion charges may exceed first cost with no
limitation.

20. Capital Recovery (Factors of Annual Cost)

20.1 Using Sinking Fund Method
Capital Recovery = Annual Depreciation + Interest on Capital
FC − SV
Annual Depreciation =
(1 + i )n − 1
i
Interest on Capital = i(FC )
20.2 Using Straight Line Method
Capital Recovery = Annual Depreciation + Average Interest
FC − SV
Annual Depreciation =
n
i  n +1 
Interest on Capital =  (FC − SV ) + i(SV )
2 n 

21. Capitalized Cost

Capitalized Cost – is the sum of the first cost and the present worth of all cost of replacement, operation,
and maintenance for a long time.
Methods of Computing Capitalized Cost
21.1 For perpetual life.
OM
Capitalized Cost = FC +
i
21.2 For life n.
OM FC − SV
Capitalized Cost = FC + +
i (1 + i )n − 1

E Page 10
 E - ENGINEERING ECONOMICS (LECTURE)

Where:
OM = annual operation and maintenance cost.

22. Break-Even Analysis

Break-even analysis – is a method of determining the income to equal the expenses or the costs of two
alternatives are equal.

Break-even point – is the value of a certain variable for which the costs of two alternatives are equal.

Income = Expenses
P(x ) = M ( x ) + L( x ) + V ( x ) + FC
Where:
x = no. of units produced and sold
P = selling price per unit
M = material cost per unit
L = labor cost per unit
V = variable cost per unit
FC = first cost

23. Business Organizations

Types of Business Organizations (Forms of Business or Company Ownership)
23.1 Individual Ownership or Single Proprietorship - Is also termed as sole proprietorship and is the
type of ownership in business where individual exercises and enjoy rights in their own interest.
The owner has the total control of the business and makes all decisions.
23.2 Partnership – is also termed as general partnership and is an association of two or more
individuals for the purpose of operating a business as co-owners of a profit.

E Page 11
 E - ENGINEERING ECONOMICS (LECTURE)

23.3 Corporation – is an artificial being created by operation of law, having the right of succession
and the powers, attributes, and properties expressly authorized by law or incident to its
existence. It is an association of not less than five but not more than 15, all of legal age.
Private corporation – are those formed for some private purpose or benefits.
Public corporation – are those formed or organized for the government.
Semi-public corporation – are those formed that is partly government and partly a private
individual.
Quasi-public corporation – are those formed for public utilities and contracts, involving public
duties but which are organized for profit.
Non-profit organization – are those formed for community service and religious activities, but
organized for non-profit.

Four Classes of Persons Composing a Corporation

23.3.1 Corporators – are those who compose the corporation.
23.3.2 Incorporators – are those corporators originally (5-15) forming and composing the
corporation.
23.3.3 Stockholders – are owners of shares of stock.
23.3.4 Members – are corporators of corporation who has no capital stock.

Stock – a certificate of owners corporation

a. Common stock – a residual owners of a corporation.
b. Preferred stock – which entitles the holder thereof to certain preferences over the holder of
common stock.

24. Contract
Contract – is a legally binding agreement to exchange services.
24.1 Four Basic Requirements in a Contract
24.1.1 There must be a clear, specific and definite offer with no room for misunderstanding.
24.1.2 There must be some form of conditional future payments.
24.1.3 There must be an acceptance of the contract and the agreement must be voluntary.
24.1.4 Both parties must have legal capacity and the purpose must be legal.
24.2 Breach of contract – it occurs when one party fails to satisfy all obligations of the contract.
24.3 Negligence – is an action, whether willful or unwillful, which is taken without proper care for
safety, resulting to property damages or injury to persons.
24.4 Torts – a civil wrong committed by one person causing damage to another person or his
property, emotional well-being, or reputation.
25. Bond
Bond – a certificate of indebtedness of a corporation usually for a period of not less than 10 years and
guaranteed by a mortgage on certain assets of the corporation or the subsidiaries.
25.1 Types of bonds
25.1.1 Mortgage bonds – a type of bond in which the security behind are the assets of the
corporation.

E Page 12
 E - ENGINEERING ECONOMICS (LECTURE)

25.1.2 Collateral bonds – a type of bond in which the security behind are the assets of a well
known subsidiary.
25.1.3 Debenture bonds – a type of bond in which there is no security behind except a promise
to pay.
25.2 Bond Value
P = Fr (P A , i %, n) + R(P F , i%, n)
Where:
P = value of bond n periods before maturity
F = face or par value of the bond
Fr = periodic dividend
n = number of periods
R = redeemable value (usually equal to face or par value)
i = investment rate

26. Basic Investment Studies

26.1 Rate of return – usually stated in percent per year and is an effective annual interest rate.
Net Profit
Rate of Return =
Total Investment
26.2 Payout period – is the length of time the investment can be recovered.
Total Investment − Salvage Value
Payout Period =
Net Annual Cash Flow

27. Selection of Alternatives

27.1 Present Economy
This involves selection of alternatives in which interest or time value of money is not a factor.
Studies usually involve the selection between alternative designs, materials, or methods.
27.2 Rate of Return
Rate of return – is usually stated in percent per year and is an effective annual interest rate. The
alternative which gives a higher rate of return on investment is then the favorable choice.
27.3 Payout Period
Payout period – this usually expressed in years and is the length of time for the net annual profit
to equal the initial investment.
27.4 Annual Cost
Annual Cost = Depreciation + Interest on Capital + Operation and Maintenance + Other out-of-
pocket Expenses
The alternative with a lower annual cost is then the more economical alternative.
27.5 Present Worth
Present Worth - is applicable when the alternatives involve future expenses whose present
value can be easily determined.

E Page 13
 E - ENGINEERING ECONOMICS (LECTURE)

27.6 Future Worth

Future Worth – is applicable when the alternatives involve expenses whose future worth is
more suitable basis of comparison.

28. Replacement Studies

Replacement studies – is an application of selection of alternatives in which the alternatives are to replace
the old equipment with a new one or to continue using the old equipment.
28.1 Rate of Return
Savings Incurred By Replacement
Rate of Return =
Additional Capital Required
28.2 Annual Cost
Annual Cost = Depreciation + Interest on Capital + Operation and Maintenance + Other out-of-
pocket Expenses

In computing depreciation and interest of the old equipment in either method, actual present
realizable values and not historical values should be used.

29. Benefit-to-Cost Ratio in Public Projects

Benefit-to-Cost Ratio – is commonly used in public project evaluations where present worth of all benefits is
divided by the present worth of all costs.

Where:
FC = first cost
SV = salvage value at the end of life
n = useful life
OM = annual operation and maintenance cost
i = interest rate or worth of money
B = annual benefits, that is, the annual worth of benefits incurred because of the existence of the project.
C = annual equivalent of the cost
C = FC ( A P , i%, n ) − SV ( A F , i%, n)
Benefit-to-Cost Ratio
B − OM
B C=
C
B/C should be greater than 1 for the project to be justifiable.

E Page 14
 E - ENGINEERING ECONOMICS (LECTURE)

30. Economic Order Quantity

Economic order quantity (E O Q) – is the order quantity which minimized the inventory cost per unit time.
An assumption of the basic (E O Q) with no shortages: “There is no upper bound on the quantity ordered.”
2ak
E OQ =
h
Where:
a = the constant depletion rate (items per unit time)
k = the fixed cost per order, Pesos
h = the inventory storage cost (Pesos per item per unit time)

31. Principles of Accounting

31.1 Bookkeeping System
Bookkeeping system – is used to record all financial transactions of the company. All
transactions are recorded in a journal then categorized and posted in a ledger. A ledger is
classified into asset, liability and owner’s equity.
31.2 Balancing System
Balancing system – where balancing the book means maintaining the equality of the basic
accounting equation:
Assets = Liability + Owner’s Equity

Double entry bookkeeping system - is a balancing system by maintaining the equality by

entering each transaction into two ledger accounts. All transactions are either debits or credits.
For liability and owner’s equity, credit increases the account and debt decreases the account.
31.3 Cash System
Cash system – is the simplest form of bookkeeping system and transactions recorded into the
journals are the present cash and expenses.
31.4 Financial Statements
Financial statements – the process of determining the success or failure of the company.
Financial statements are usually evaluated by accountants, business management and
stockholders.
31.4.1 Two Types of Financial Statements
31.4.1.1 Balance sheet – is the presentation of the basic accounting equation.
31.4.1.2 Profit and loss statement – is the presentation of income source and
expenses. This is also known as statement of income and retained
earnings. Examples of income or revenue are sales, interest, etc. and for
expenses are salaries, supplies, utilities, etc.
31.4.2 Terms used in the Balance Sheets
31.4.2.1 Current assets – also known as liquid assets and defined as cash and
other assets that can be converted quickly into cash such as accounts
receivable and merchandise.

E Page 15
 E - ENGINEERING ECONOMICS (LECTURE)

31.4.2.2 Fixed assets – are properties that will not be converted into cash or
difficult to convert into cash such as buildings, land, machinery,
equipment and fixtures.
31.4.2.3 Current liabilities – are liabilities which will due within a short period,
usually a year such as accounts payable and accrued expenses.
31.4.2.4 Long-term liabilities – are liabilities that are not payable within a short
period of time such as notes payable and mortgage.
31.4.3 Terms used in the Financial Statements
31.4.3.1 Current ratio – an index of short term paying ability.
Current Assets
Current Ratio =
Current Liabilities
31.4.3.2 Acid-test ratio – also known as quick ratio and defined as measure of
short-term paying ability.
Quick Assets
Acid − Test Ratio =
Current Liabilities
31.4.3.3 Receivable turn-over – measures the speed of collections of accounts
receivables.
Net Sales on Credit
Receivable Turnover =
Average Receivables
31.4.3.4 Gross margin – gross profit as a percentage of sales.
Gross Profit
Gross Margin =
Net Sales
31.4.3.5 Profit margin ratio – percentage of sales that is net income.
Net Income Before Tax
Profit Margin Ratio =
Net Sales
31.4.3.6 Return on investment ratio – percent return on the investment.
Net Income
Return on Investment =
Owner ' s Equity

– end -

E Page 16