Engineering Economy

Annuities, Capitalized Cost, and Amortization

Engineering Economy
Annuities, Capitalized Cost, and Amortization

Definition of Terms
1. Annuity
2. Ordinary Annuity
1+𝑖 𝑛 −1
3. =Uniform series compound amount factor
𝑖

𝑖
4. [(1+𝑖)𝑛−1] =Sinking fund factor

5. Capital Recovery Factor = sinking fund factor + i

6. Deferred Annuity
7. Capitalized Cost
8. Amortization
Engineering Economy
Annuities, Capitalized Cost, and Amortization

Ordinary Annuity
Finding A when P is given
Finding P when A is given
𝟏−(𝟏+𝒊)−𝒏 𝒊
𝑷= 𝑨[ ] 𝑨 = 𝑷[ −𝒏
]
𝒊 𝟏− 𝟏+𝒊
𝑃 Finding A when F is given
𝑃 = 𝐴( , 𝑖%, 𝑛)
𝐴 𝑖
𝐴 = 𝐹[ ] ;
1+𝑖 𝑛 −1
Finding F when A is given 𝐹
𝟏+𝒊 𝒏−𝟏 A= 𝐹( , 𝑖%, 𝑛)
𝐴
𝑭 = 𝑨[ ]
𝒊
𝐹
𝐹 = 𝐴( , 𝑖%, 𝑛)
𝐴
Engineering Economy
Annuities, Capitalized Cost, and Amortization

Deferred Annuity
Finding P when A is given

𝟏− 𝟏+𝒊 −𝒏
𝑷 = 𝑨[ ](𝟏 + 𝒊)−𝒎
𝒊
𝑝 𝑃
𝑃 = 𝐴( , 𝑖%, 𝑛)( , 𝑖%, 𝑚)
𝐴 𝐹
Engineering Economy
Annuities, Capitalized Cost, and Amortization

Annuity Due

−𝒏+𝟏
𝟏− 𝟏+𝒊
𝑷 = 𝑨 + 𝑨[𝟏 + ]
𝒊
𝑝
𝑃 = 𝐴 + 𝐴( , 𝑖%, 𝑛 − 1)
𝐴
Engineering Economy
Annuities, Capitalized Cost, and Amortization

Perpetuity
1−(1+𝑖)−𝑛
𝑃= 𝐴[ ]
𝑖

1−(1+𝑖)−∞
𝑃= 𝐴[ ]
𝑖

𝑨
𝑷=
𝒊
Engineering Economy
Annuities, Capitalized Cost, and Amortization

Capitalized Cost
Case 1: Maintenance Only

𝑨 Where:
𝑪𝑪 = 𝑭𝑪 +
𝒊
𝐶𝐶 = 𝐶𝑎𝑝𝑖𝑡𝑎𝑙𝑖𝑧𝑒𝑑 𝑐𝑜𝑠𝑡
Case 2: Replacement Only
𝐹𝐶 = 𝐹𝑖𝑟𝑠𝑡 𝑐𝑜𝑠𝑡
𝑺
𝑪𝑪 = 𝑭𝑪 + 𝑆 = 𝑎𝑚𝑜𝑢𝑛𝑡 𝑡𝑜 𝑟𝑒𝑝𝑙𝑎𝑐𝑒 𝑎 𝑝𝑟𝑜𝑝𝑒𝑟𝑡𝑦 𝑒𝑣𝑒𝑟𝑦 𝑘 𝑝𝑒𝑟𝑖𝑜𝑑
𝟏+𝒊 𝑲 −𝟏

𝑘 = 𝑝𝑒𝑟𝑖𝑜𝑑
Case 3: Maintenance and Replacement

𝑨 𝑺
𝑪𝑪 = 𝑭𝑪 + +
𝒊 𝟏+𝒊 𝒌−𝟏
 Engineering Economy
Annuities, Capitalized Cost, and Amortization
Solved Problems on Annuities
1. A chemical engineer wishes to set up a special fund by making uniform semi-annual end-of-period
deposits for 20 years. The fund is to provide P100, 000 at the end of each of the last five years of the
20-year period. If interest is 8% compounded semi-annually, what is the required semi-annual deposit to
be made?
8%
𝐹𝑜𝑟 𝑡ℎ𝑒 𝑑𝑒𝑝𝑜𝑠𝑖𝑡𝑠, 𝑖 = = 4%
2
𝐹𝑜𝑟 𝑡ℎ𝑒 𝑤𝑖𝑡ℎ𝑑𝑟𝑎𝑤𝑎𝑙𝑠, 𝑖 = 1 + 0.04 2 − 1 = 0.0816 𝑜𝑟 8.16%
Using 20 years from today as the focal date, the equation of value is
𝐴 𝐹/𝐴, 4%, 40 = 𝑃100, 000 (𝐹/𝐴, 8.16%, 5)
𝐴 95.0255 = 𝑃100, 000(5.8853)
𝑨 = 𝑷𝟔, 𝟏𝟗𝟑. 𝟑𝟗
Engineering Economy
Annuities, Capitalized Cost, and Amortization
2. If money is worth 8% compounded quarterly, compare the present values of the following:
a) An annuity of P1000 payable quarterly for 50 years;
b) An annuity of P1000 payable quarterly for 100 years;
c) A perpetuity of P1000 payable quarterly.
Solution:

1− 1+0.02 −200
a) P = P1, 000 = 𝐏𝟒𝟗, 𝟎𝟒𝟕. 𝟑𝟓
0.02

1− 1+0.02 −400
b) P = P1, 000 = 𝐏𝟒𝟗, 𝟗𝟖𝟏. 𝟖𝟓
0.02

1000
c) P = = 𝐏𝟓𝟎, 𝟎𝟎𝟎
0.02
Engineering Economy
Annuities, Capitalized Cost, and Amortization
3. A steam boiler is purchased on the basis of guaranteed performance. However, initial tests indicate
that the operating cost will be P40, 000 more per year than guaranteed. If the expected life is 25
years and money is worth 10%, what deduction from the purchased price would compensate the
buyer for the operating cost?
1−(1+𝑖)−𝑛
Solution: 𝑃= 𝐴[ ]
𝑖

−25
1 − 1 + 0.1
𝑃 = 𝑃40, 000[ ]
0.1
𝑷 = 𝑷𝟑𝟔𝟑, 𝟎𝟖𝟏. 𝟔𝟎
Engineering Economy
Annuities, Capitalized Cost, and Amortization
6. If P10, 000 is deposited each year for 9 years, how much annuity can a person get annually from the
bank every year for 8 years starting 1 year the 9th deposit is made. Cost of money is 14%.
Solution:
Using today as the focal date, the equation of value is
A(P/A, 14%, 8) (P/F, 14%, 9) = P10, 000 (P/A, 14%, 9)
−8 −9
1 − 1 + 0.14 −9
1 − 1 + 0.14
𝐴 1 + 0.14 = 𝑃10, 000
0.14 0.14
A (4.63886) (0.30751) = P10, 000 (4.94637)
A= P34, 675
Engineering Economy
Annuities, Capitalized Cost, and Amortization

Using 9 years from today as a focal date, the equation of value is

A (P/A, 14%, 8) = P10, 000 (F/A, 14%, 9)
A (4.63886) = P10, 000 (16.08535)
A = P34, 675

Using 17 years from today as the focal date, the equation of value is
A (F/A, 14%, 8) = P10, 000 (F/A, 14%, 9) (F/P, 14%, 8)
A (4.63886) = P10, 000 (16.08535) (2.85259)
A = P34, 675
Engineering Economy
Annuities, Capitalized Cost, and Amortization

7. A man invests P100, 000 now for the college education of his 2-year old son. If the fund earns 14%
effective, how much will the son get each year starting from his 18th to 22nd birthday?
Solution:

−5
1 − 1 + 0.14 −15
100000 = 𝐴 1 + 0.14
0.14

𝑨 = 𝑷𝟐𝟎𝟕, 𝟗𝟏𝟔. 𝟑𝟗
Engineering Economy
Annuities, Capitalized Cost, and Amortization

8. A person buys a piece of property for P100,000 down payment and ten deferred semi-annual
payments of P8000 each starting three years from now. What is the present value of the investment if
the rate of interest is 12% compounded semi-annually?
Solution: 𝐿𝑒𝑡 𝑃𝑇 𝑏𝑒 𝑡ℎ𝑒 𝑝𝑟𝑒𝑠𝑒𝑛𝑡 𝑤𝑜𝑟𝑡ℎ 𝑜𝑓 𝑎𝑙𝑙 𝑝𝑎𝑦𝑚𝑒𝑛𝑡𝑠
𝑃5 𝑏𝑒 𝑡ℎ𝑒 𝑝𝑟𝑒𝑠𝑒𝑛𝑡 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑖𝑛𝑠𝑡𝑎𝑙𝑙𝑚𝑒𝑛𝑡 𝑎𝑡 𝑝𝑒𝑟𝑖𝑜𝑑 5

1 − 1 + 0.06 −5
−5
𝑃5 = 80000 1 + 0.06 = 43999.08162
0.06

𝑃𝑇 = 100000 + 43999.08162
𝑷𝑻 = 𝑷𝟏𝟒𝟑 𝟗𝟗𝟗. 𝟎𝟖
Engineering Economy
Annuities, Capitalized Cost, and Amortization

14. A debt of P5000 with interest at 12% compounded semi-annually is to be amortized by equal
semiannual payments over the next 3 years, the first due in six months. Find the semi-annual
payment and construct an amortization schedule.
Solution:

𝑖
𝐴=𝑃 −𝑛
1− 1+𝑖

0.06
𝐴 = 5000 −6
1 − 1 + .06
𝑨 = 𝟏𝟎𝟏𝟔. 𝟖𝟐
Engineering Economy
Annuities, Capitalized Cost, and Amortization

Amortization Schedule

Outstanding Principal at Interest due at end of Principal repaid at end of

Period Payment
the beginning of period period period

1 5000.00 300.00 1016.82 716.82

2 4283.18 256.99 1016.82 759.83
3 3523.35 211.40 1016.82 805.42
4 2717.93 163.08 1016.82 853.74
5 1864.19 111.85 1016.82 904.97
6 959.22 57.55 1016.82 959.27
Totals P1100.87 P6,100.92 P5000.05
Engineering Economy
Annuities, Capitalized Cost, and Amortization

15. A debt of P10, 000 with interest at the rate of 20% compounded semi-annually is to be amortized by
five equal payment is to be made after 3 years. Find the semi-annual payment and construct an
amortization schedule.
Solution:

𝑃 = 𝐴 𝑃/𝐴, 10%, 5 (𝑃/𝐹, 10%, 5)

𝐴𝑚𝑜𝑟𝑡𝑖𝑧𝑎𝑡𝑖𝑜𝑛 = 𝑃(𝐴/𝑃, 10%, 5)(𝐹/𝑃, 10%, 5)
= 𝑃10, 000 0.2638 1.6105
𝑨 = 𝑷𝟒, 𝟐𝟒𝟖. 𝟓𝟎
Engineering Economy
Annuities, Capitalized Cost, and Amortization
Amortization Schedule

Outstanding principal Interest due at end of Principal repaid at

Period Payment
at beginning of period period end of period

1 P10, 000.00 P1, 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 P4, 248.50 P2, 637.99
7 13, 467.11 1, 346.71 4, 248.50 2, 901.79
8 10, 565.32 1, 056.53 4, 248.50 3, 191.97
9 7, 373.35 737.34 4, 248.50 3, 511.16
10 3, 862.19 386.22 4, 248.50 3, 862.28
TOTALS P11, 242.41 P21, 242.50 P16, 105.19