John Patrick F.

Orfano BS EE – 2nd Year

ES032 Engineering Economics – Assignment 6

Problems:

1. An enterprising student invests $1,000 at an annual interest rate that will grow
the original investment to $2,000 in 4 years. In 4 more years, the amount will grow
to $4,000, and this pattern of doubling every 4 years repeats over a total time span
of 36 years. How much money will the student gain in 36 years? What is the
magical annual interest rate the student is earning?
2. If a certain machine undergoes a major overhaul now, its output can be
increased by 20%, which translates into additional cash flow of $20,000 at the end
of each year for 5 years. If i = 15% per year, how much can we afford to invest to
overhaul this machine?
3. You can buy a machine for $100,000 that will produce a net income, after
operating expenses, of $10,000 per year. If you plan to keep the machine for 4
years, what must the market (resale) value be at the end of 4 years to justify the
investment? You must make a 15% annual return on your investment.
4. An expenditure of $20,000 is made to modify a material-handling system in a
small job shop. This modification will result in first-year savings of $2,000, a
second-year savings of $4,000, and a savings of $5,000 per year thereafter. How
many years must the system last if an 18% return on investment is required? The
system is tailor made for this job shop and has no market (salvage) value at any
time.
5. Find the uniform annual amount that is equivalent to a uniform gradient series in
which the first year’s payment is $500, the second year’s payment is $600, the
third year’s payment is $700, and so on, and there are a total of 20 payments. The
annual interest rate is 8%.
6. A geometric gradient has a positive cash flow of $1,000 at EOY zero (now), and
it increases 5% per year for the following 5 years. Another geometric gradient has
a positive value of $2,000 at the EOY 1, and it decreases 6% per year for years two
through five. If the annual interest rate is 10%, which geometric gradient would
you prefer?
Answers and Solutions:
1.) Given that,

F = $2000
P = $1000
N = 4 years
Using manual tabulation for total money gained,
time Amount
4 years $2000
4 years $4000
4 years $8000
4 years $16000
4 years $32000
4 years $64000
4 years $128000
4 years $256000
4 years $512000
TOTAL: 36 years $1,022,000

From the table presented, the student gained a total of $1,022,000 in 36 years.
Solving for the magical annual interest,
F = P(1+i)N
$2000 = $1000 (1+i)4
($2000/$1000) = (1+i)4
Isolating i,
i = 21/4 – 1
i = 0.1892 or 18.92% per annum
 2.) Given that,
A = $20,000
i = 15% per annum
n = 5 years
investmax = Total sum of present value of the additional cash flow of $20,000 at
the end of each year for 5 years
= [$20,000/(1+0.15)]+[$20,000/(1+0.15)2]+[$20,000/(1+0.15)3]+
[$20,000/(1+0.15)4]+[$20,000/(1+0.15)5]
= $17,391.31 + $15,122.88 +$13,150.33 + $11,435.07 + $9,943.54
investmax = $67,043.13
The maximum investment that the company can afford to overhaul the machine is
$67,043.13

3.) Given that,

i = 15% per annum
n = 4 years , 5th year for resale
A = $10,000
Let x be the resale value
$100,000 = [$10,000/(1+0.15)]+[$10,000/(1+0.15)2]+[$10,000/(1+0.15)3]+
[$10,000/(1+0.15)4]+[x/(1+0.15)4]
= $8,695.66 + $7,561.44+ $6,575.17 + $5,717.54 + 0.5718x
Isolating x,
0.5718x = $71,450.19
x = $124,956.61
To justify the investment, the resale value for the machine should be $124,956.61.
 4.) Following the initial cash flow,

Time Cash Flow

0 -$20,000
1 year $2,000
2 years $4,000
3 years $5,000
N-years $5,000

Using this equation Inflow = Outflow,

$2000(P/F,18%,1) + $4000(P/F,18%,2) + $5000(P/A,18%,N-2)(P/F,18%,2) = $20,000
Using the values in the table of discrete compounding at i = 18% per annum,
(P/F,18%,1) = 0.8475
(P/F,18%,2) = 0.7182
Substituting to the equation,
$2000(0.8475) + $4000(0.7182) + $5000(P/A,18%,N-2)(0.7182) = $20,000
$1695 + $2872.8 + $3591(P/A,18%,N-2) = $20,000
Isolating (P/A,18%,N-2)
(P/A,18%,N-2) = [($20,000-$1695-$2872.8)/$3591]
(P/A,18%,N-2) = 4.2975
Since (P/A,18%,9) has a value of 4.3030 while (P/A,18%,8) has a value of 4.0776,
making (P/A,18%,9) nearer to the solved value, therefore:
N-2 = 9
N = 11 years
To ensure 18% return of investment, the system must last up to 11 years.
5.) Following the manual tabulation given a total of 20 payments,
Year Payment
1 $500
2 $600
3 $700
4 $800
5 $900
6 $1000
7 $1100
8 $1200
9 $1300
10 $1400
11 $1500
12 $1600
13 $1700
14 $1800
15 $1900
16 $2000
17 $2100
18 $2200
19 $2300
20 $2400
Solving for A,
A = $500 + $100(A/G,8%,20)
= $500 + $100(7.0369)
A = $1,203.69
The uniform annual amount that is equivalent to the tabulated uniform gradient series is
$1,203.69
6.) For the first geometric gradient
Ps1 = $1000 + [($1000)(1+0.05)(1-(P/F,10%,5)(F/P,5%,5))] / [0.1 – 0.05]
= $1000 + [($1000)(1.05)(1-(0.6209)(1.2763))] / 0.05
= $1000 + $4358.46
Ps1 = $5358.46

For the second geometric gradient

Ps2 = $2000[1-(P/F,10%5)(1-0.06)5] / [0.1+0.06]
= $2000[1-(0.6209)(0.7339)] / 0.16
= $2000[0.5443] / 0.16
Ps2 = $6803.75

Since Ps2 > Ps1 , choose Ps2