Econ 02 Nvsu FR Icd 05 00

Republic of the Philippines
NUEVA VIZCAYA STATE UNIVERSITY

Bambang, Nueva Vizcaya
INSTRUCTIONAL MODULE
IM No.2:ENGG04-1S-2021-2022
College : COLLEGE OF ENGINEERING

Campus: BAMBANG CAMPUS
DEGREE PROGRAM Bachelor of COURSE NO. ENG’G 04

Science in
Mechanical
Engineering
SPECIALIZATION Mechanical COURSE TITLE Engineering Economics
YEAR LEVEL 3rd Year TIME FRAME 12 hrs WK NO. 2 - 5 IM NO. 2
I. UNIT TITLE/CHAPTER TITLE:
CHAPTER 2. MONEY TIME RELATIONSHIPS AND EQUIVALENCE
II. LESSON TITLE:
1. Interest and Time Value of Money

1.1. Simple Interest
1.2. Compound Interest
1.3. Rates of interest
2. Cash Flows
2.1. Viewpoint of the lender
2.2. Viewpoint of the borrower
3. The Concept of Equivalence
3.1. Equation of Value
3.2. Discount
3.3. Annuities
3.4. Amortization
3.5. Uniform Gradient Series
3.6. Depreciation
III. LESSON OVERVIEW

This module gives an overview and discussion regarding the concepts behind interest and time value
of money, cash flows and concepts of equivalence. Moreover, the students will engage to construct cash
flow diagrams and make calculations regarding interest and cash equivalence.
IV. DESIRED LEARNING OUTCOMES

At the end of the lesson, the students should be able to:
1. provide understanding of the return capital in the form of interest.
2. illustrate how basic time value calculations are made relating to the cost of capital in engineering
economic studies.
3. draw properly the cash flow diagram
V. LESSON CONTENT
MONEY TIME RELATIONSHIPS AND EQUIVALENCE
1. INTEREST AND TIME VALUE OF MONEY

Interest is the amount of money paid for the use of borrowed capital or the income produced by
money which has been loaned.
NVSU-FR-ICD-05-00 (081220) In accordance with Section 185, Fair Use of a Copyrighted Work of Republic Act 8293, the Page 1 of 25
copy righted works included in this material may be reproduced for educational purposes
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IM No.2:ENGG04-1S-2021-2022
Types of Interest
1.1. Simple Interest. Simple interest is calculated using the principal only, ignoring any interest
that had been accrued in preceding periods. In practice, simple interest is paid on short term loans
in which the time of the loan is measured in days. It is calculated as:
I = Pin
F=P+I
F = P (1 + in)
where:
I = interest
P = principal or present worth
n = number of interest per interest period
i = rate of interest per interest period
F = accumulated amount or future worth
Two Classifications of Simple Interest

1.1.1. Ordinary Simple Interest – it is computed on the basis of 12 months of 30 days each or
360 days a year.
1 interest period = 360 days
1.1.2. Exact Simple Interest – it is based on the exact number of days in a year, 365 days for
an ordinary year and 366 days for a leap year.
1 interest period = 365 or 366 days
Test for leap year = divisible by four
Example 1. Determine the ordinary simple interest on P700 for 8 months and 15 days if the rate of
interest is 15%
Solution:
30 𝑑𝑎𝑦𝑠
Number of interest days = 8 mo. x + 15 days = 255 days
1 𝑚𝑜.
255 𝑑𝑎𝑦𝑠
I = Pin = (P 700)(0.15)( 360 𝑑𝑎𝑦𝑠) = P74.38
Example 2. Determine the exact simple interest on P500 for the period from January 10 to October
28,1992 at 16% interest.
Solution:
1992
Test for leap year = = 498 exact divisible
4
Month of the Year No. of days

January 10 – 31 21 ( excluding Jan. 10)
February 29
March 31
April 30
May 31
June 30
July 31
August 31
September 30
October 28 (including Oct. 28)
Total no. of days 292 days
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Exact Simple Interest = P500 x 0.16 x = P 63.83
1.2. Compound Interest. In compound interest, the interest for an interest period is calculated
on the principal plus total amount of interest accumulated in previous periods. Thus compound
interest means “interest on top of interest.”
Interest Principal at Beginning Interest Earned Amount at End of Period

Period of during
1 P Pi P + Pi = P(1 + i)
2 P(1 + i) P(1 + i)i P(1 + i) + P(1 + i)i = P(1 + i)2
3 P(1 + i)2 P(1 + i)2i P(1 + i)2 + P(1 + i)i = P(1 + i)3
n P(1 + i)n-1 P(1 + i)n-1i P(1 + i)n
Therefore, the formula for compound interest is:
F = P (1 + i)n or in its notation F = P(F/P, i%, n) ---→ future worth

P = F (1 + i)-n or in its notation P = F(P/F, i%, n) ---→ present worth
where:
(1 + i)n is called the single payment compound amount factor
(1 + i)-n is called the single payment present worth factor
Example 3. A chemical engineer wished to accumulate a total of P10,000.00 in a savings account

at the end of 10 years. If the bank pays only 4% compounded quarterly, what should be the initial
deposit?
Solution: Since it is compounded quarterly

n = 10 x 4 = 40 interest periods
0.04 40
F = P ( 1+i)n = P10,000 (1 + ) = P6,716.53
4
Example 4. By the condition of a will, the sum of P25,000 is left to a girl to be held in trust by her
guardian until it amounts to P45,000. When will the girl receive the money if the fund is invested
at 8% compounded quarterly?
Solution: Since it is compounded quarterly
P = P25,000
F = P 45,000
F = P (1+i)n
0.08 n
P45,000 = P25,000 (1 + )
4
1.8 = 1.02n
ln 1.8
𝑛= = 29.69 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑝𝑒𝑟𝑖𝑜𝑑𝑠
ln 1.02
𝟐𝟗.𝟔𝟗
No. of years = = 7.42 years
𝟒
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1.3. RATES OF INTEREST

1.3.1. Nominal rate of interest. The nominal rate of interest specifies the rate of interest
and a number of interest periods in one year.
𝑟
𝑖=
𝑚
where:
i = rate of interest per interest period
r = nominal rate of interest
m = number of compounding periods per year
Compounding Frequency
Compounding Frequency Number of Compounding Periods per Year
Annually 1
semi – annually 2
Quarterly 4
Bimonthly 6
Monthly 12
Daily 365
continuous ern
1.3.2. Effective rate of interest. Effective rate of interest is the actual or exact rate of
interest on the principal during one year.
Example 5. Find the nominal rate which if converted quarterly could be used instead of 12%
compounded monthly. What is the corresponding effective rate?
Solution:
Let: r = the unknown nominal rate
For two or more nominal rates to be equivalent, their corresponding effective rates must be equal.
Nominal Rate Effective Rate

𝑟
r% compounded quarterly (1 + 4)4 – 1
0.12 4
12% compounded monthly (1 + ) – 1
12
(1 + 𝑟4)4 – 1 = (1 + 0.12
12
)4 – 1
r = 12.12% compounded quarterly
Thus, 12% compounded monthly is equivalent to 12.12% compounded quarterly.

0.12 12
Effective rate = (1 + ) – 1 = 12.68%
12
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2. CASH FLOWS
A cash flow diagram is imply a graphical representation of cash flows drawn on a time scale. Cash
flow diagram for economic analysis problems is analogous to that of free body diagram for mechanics
problems.
receipt (positive cash flow or cash inflow)
disbursement (negative cash flow or cash outflow)
Example: A loan of P100 at a simple interest of 10% will become P150 after 5 years
2.1. Viewpoint of a Lender

P150
0 1 2 3 4 5
P 100
2.2. Viewpoint of a Borrower
P 100
0 1 2 3 4 5
P150
Notations:
Year 0 – beginning of year 1
Year 1 – end of year 1, beginning of year 2
Year 2 – end of year 2, beginning of year 3
3. THE CONCEPT OF EQUIVALENCE

Definition: Combination of interest rate (rate of return) and time value of money to determine different
amounts of money at different points in time that are economically equivalent.
How it works: Use rate i and time t in upcoming relations to move money (values of P, F and A) between
time points t = 0, 1, …, n to make them equivalent (not equal) at the rate i
Different sums of money at different times may be equal in economic value at a given rate
IM No.2:ENGG04-1S-2021-2022
3.1. The Equation Value

An equation of value is obtained by setting the sum of the values on a certain comparison
or focal date of one set of obligations equal to the sum of the values on the same date of another
set of obligations.
Example: A man bought a lot worth P 1M if paid in cash. On the installment basis, he paid a down
payment of P200,000; P300,000 at the end of one year P400,000 at the end of three years and a final
payment at the end of five years. What was the final payment if interest was 20%?
Solution: Cash flows going to present
Let Q = the final payment
P 800,000
0 1 2 3 4 5
P300K
P 400K (P/F, i%, n) P 400K
Q
Q (P/F, i%, n)
Using today @ t = 0 , the equation of value is:
P 800,000 = P 300,000 (P/F, 20%, 1) + P400,000 (P/F, 20%, 3) + Q (P/F, 20%, 5)

P 800,000 = P 300,000 (1.20)-1 + P400,000 (1.20)-3 + Q (1.20)-5
Q = P792,560.00
Another Solution: Cash flows going to future
Let Q = the final payment
P 800,000
0 1 2 3 4 5
P300K
P 400K (F/P, i%, n)
Q
P 300K (F/P, i%, n)
P 800,000 (F/P, 20%, 5) = P 300,000 (F/P, 20%, 4) + P400,000 (P/F, 20%, 2) + Q

P 800,000 (1.20)5 = P 300,000 (1.20)4 + P400,000 (1.20)2 + Q
Q = P792,560.00
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3.2. Discount
Discount on a negotiable paper is the difference between the present worth (the amount
received for the paper in cash) and the worth of paper at some time in the future (the face value
of the paper or principal). Discount is interest deducted in advance.
(1 + i)-1
P 1.00
d = 1 – (1 + i)-1
𝑑
i=
1−𝑑
where:
d = rate of discount for the period involved
i = rate of interest for the same period
Example. A man borrowed P 5,000 from a bank and agreed to pay the loan at the end of 9 months. The
bank discounted the loan and gave him P 4,000 in cash.
a. What is the rate of discount?
b. What was the rate of interest?
c. What was the rate of interest for one year?
Solution:
P 4,000 P 0.80
P5,000 P1.00
a. rate of discount
𝑑𝑖𝑠𝑐𝑜𝑢𝑛𝑡 𝑃1,000
d= = 𝑥 100 = 20%
𝑝𝑟𝑖𝑛𝑐𝑖𝑝𝑎𝑙 𝑃5,000
Another solution:
d = 1 – 0.80 = 0.20 or 20%
IM No.2:ENGG04-1S-2021-2022
b. rate of interest
𝑑 0.20
i = 1−𝑑 = 1−0.20 = 0.25 or 25%
Another solution:
𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑃1,000
i = 𝑝𝑟𝑖𝑛𝑐𝑖𝑝𝑎𝑙 𝑎𝑐𝑡𝑢𝑎𝑙𝑙𝑦 𝑟𝑒𝑐𝑒𝑖𝑣𝑒𝑑 = 𝑃4,000 = 0.25 or 25%
c. rate of interest for one year

𝐼 𝑃1000
i = 𝑃𝑛 = i = 9 = 0.3333 or 33%
(𝑃4000)( )
12
3.3. Annuities
An annuity is a series of equal payments occurring at equal period of time.
Symbols and their meaning:

P = value or sum of money at present
F = value or sum of money at some future time
A = a series of periodic, equal amounts of money
n = number of interest period
i = interest rate per interest period
3.3.1. Ordinary Annuity
An ordinary annuity is one where the payments are made at the end of each
period.
The formulas for ordinary annuity are the following:

𝟏 −(𝟏+𝒊)−𝒏 (𝟏+𝒊)−𝒏 −𝟏
P=A( ) =A( ) Notation: P = A(P/A, i%, n)
𝒊 𝒊(𝟏+𝒊)𝒏
𝒊
A = P (𝟏 −(𝟏+𝒊)−𝒏 ) Notation: A = P(A/P, i%, n)
(𝟏+𝒊)𝒏 −𝟏
F=A( ) Notation: F = A(F/A, i%, n)
𝒊
Sinking Fund
▪ Any account that is established for accumulating funds to meet future obligations or debts
is called a sinking fund.
IM No.2:ENGG04-1S-2021-2022
▪ The sinking fund payment is defined to be the amount that must be deposited into an
account periodically to have a given future amount.
𝒊
A = F ((𝟏+𝒊)𝒏 −𝟏) Notation: A = F(A/F, i%, n)
Example 1. What are the present worth and the accumulated amount of a 10-year annuity P10,000 at
the end of each year, with interest at 15% compounded annually?
Solution:
A = P10,000 n = 10 I = 15% F
P P 10,000 (F/A, 15%, 10)
1 2 3 9 10
0
A A A A A
P 10,000 (P/A, 15%, 10)
𝟏 −(𝟏+𝟎.𝟏𝟓)−𝟏𝟎
P = A (P/A, i%, n) = P 10,000 ( ) = P50,188.00
𝟎.𝟏𝟓
(𝟏+𝟎.𝟏𝟓)𝟏𝟎 −𝟏
F = A (F/A, i%, n) = P 10,000 ( ) = P 203,0337.00
𝟎.𝟏𝟓
Example 2. A chemical engineer wishes to set –up a special fund by making uniform semiannual
end of period deposits for 20 years. The fund is to provide P100,000 at the end of the last five
years of the 20 year period. If interest is 8% compounded semiannually, what is the required
semiannual deposit to be made?
Solution:
For annual cash flow:
IM No.2:ENGG04-1S-2021-2022
For semiannual cash flow:
Period = 20 x 2 = 40 interest periods
0 1 2 30 31 32 33 34 35 36 37 38 39 40
A A A A A A A A A A A A A
A(F/A, 4%, 40)
8%
For deposits, i = = 4%
2
For the withdrawals, i = (1 + 0.04)2 - 1 = 0.0816 8.16%
Using 20 years from today as the focal date, the equation of value:
Semiannual = Annual
A (F/A, 4%, 40) = P 100,000 (F/A, 8.16%, 5)
A (95.0255) = P 100,000 (5.8853)
A = P 6,193.39
3.3.2. Deferred Annuity

A deferred annuity is one where the first payment is made several periods after the
beginning of the annuity
𝟏 −(𝟏+𝒊)−𝒏
P=A( ) (𝟏 + 𝒊)−𝒎 Notation: P = A(P/A, i%, n) (P/F,i%,m)
𝒊
IM No.2:ENGG04-1S-2021-2022
Example 3. 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 after the 9th deposit is made. Cost of money is 14%.
Solution 1.
Deferred Part
A(P/A, 14%,8)(P/F,14%,9) A(P/A, 14%,8)
A A A A A
0 1 2 3 8 9
0 1 2 3 7 8
10K 10K 10K 10K 10K
P 10,000 (P/A, 14%, 9)
Using today (@ t = 0) as the focal date, the equation of value is:

A (P/A, 14%, 8) (P/F, 14%, 9) = P10,000 (P/A, 14%, 9)
A (4.63886)(0.30751) = P 10,000 (4.94637)
A = P 34,675.00
Solution 2.
A(P/A, 14%,8)
A A A A A
0 1 2 3 8 9
0 1 2 3 7 8
10K 10K 10K 10K 10K
P 10,000 (F/A, 14%, 9)
Using 9 years from today as the focal date, the equation of value is:
A (P/A, 14%, 8) (P/F, 14%, 9) = P10,000 (F/A, 14%, 9)
A (4.63886) = P 10,000 (16.08535)
A = P 34,675.00
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Solution 3.
A(F/A, 14%,8)
A A A A A
0 1 2 3 8 9
0 1 2 3 7 8
10K 10K 10K 10K 10K Deferred Part
P 10,000 (F/A, 14%, 9) P 10,000 (F/A, 14%, 9)(F/P,14%,8)
Using 17 years from today as the focal date, the equation of value is:
A (P/A, 14%, 8) = P10,000 (F/A, 14%, 9)(F/P, 14%, 8)
A (4.63886) = P 10,000 (16.08535)(2.85259)
A = P 34,675.00
3.3.3. Perpetuity
A perpetuity is an annuity in which the payment continue indefinitely
𝟏 −(𝟏+𝒊)−∞ 𝐀
P=A( ) = Notation: P = A(P/A, i%, n) where: n = ∞
𝒊 𝐢
Example 4. What amount of money invested today at 15% interest can provide the following
scholarships: P 30,000 at the end of each year for 6 years, P 40,000 for the next 6 years and
P 50,000 thereafter.
𝑷𝟓𝟎𝑲 𝑷𝟓𝟎𝑲
𝟎.𝟏𝟓
(P/F, 15%, 12) 𝟎.𝟏𝟓
P40K(P/A,15%,6)(P/F,15%,6) P40K(P/A,15%,6) P50K P50K
P30K(P/A,15%,6) P40K P40K P40K
P30K P30K P30K P30K P30K
0 1 2 3 6 7 10 11 12 13 14
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Using today as the focal date, the equation of value is:
𝑃50𝐾
P = P30,000 (P/A, 15%, 6) +P40,000 (P/A, 15%, 6) (P/F, 15%,6) + (P/F, 15%, 12)
0.15
𝑃50𝐾
P = P30,000 (3.7845) +P40,000 (3.7845) (0.4323) + (0.1869)
0.15
P = P 241,277.00
3.3.3.1. 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 P1.5M and
an annual maintenance of P150,000. Interest is 15%.
Solution: P 150,000 P150,000
0 1 2
𝐴 𝑃150,000
P= = = P 1,000,000.00
𝑖 0.15
Capitalized Cost = First Cost + P
= P 1.5 M + P 1 M
Capitalized Cost = P2.5 M
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 period

X amount of principal invested at rate i% the interest on which will amount to S every k periods
Xi = interest on X every period, the periodic deposit towards the accumulation of S
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A A A S S S
0 1 2 3 0 k 2k 3k
P X
𝑨 𝑺
P= X=
𝑰 (𝟏+𝒊)𝒌 −𝟏
Example 6. A new boiler was installed by a textile plant at a cost of P300,000 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 P30,000.
Determine its capitalized cost if interest is 18% compounded annually.
Solution:
P30K P30K P30K P270K P270K P270K
0 15 30 45 0 15 30 45
X
P300K P300K P300K P300K
𝑺 𝑷𝟐𝟕𝟎,𝟎𝟎𝟎
X= = (𝟏+𝟎.𝟏𝟖)𝟏𝟓 −𝟏 = P26,604.00
(𝟏+𝒊)𝒌 −𝟏
Capitalized Cost = First Cost + X = P300,000 + P26,604
Capitalized Cost = P 324,604.00
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3.4. 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 1. A debt of P5,000 with interest at 12% compounded semiannually is to be amortized by equal
semiannual payments over the next 3 years, the first due in 6 months. Find the semiannual payment and
construct an amortization schedule.
Amortization Schedule
1 2 3 4
Period Outstanding Interest due at Payment Principal repaid
principal at the end of at the end of
beginning of period period period
1 P 5,000 P300 P1016.82 P716.82
2 P4,283.18 P256.99 P1016.82 P759.82
3 P3,523.35 P211.40 P1016.82 P805.42
4 P2,717.93 P163.08 P1016.82 P853.74
5 P1,864.19 P111.85 P1016.82 P904.97
6 P959.22 P57.55 P1016.82 P959.27
Totals P1,100.87 P6,100.92 P5,000.05
Sample Calculations:
6 𝑚𝑜.
Period 1. Interest due at the end of period = Pin = (P5000)(0.12)( ) = P 300
12 𝑚𝑜.
𝑃 𝑃5000
Payment = A = (𝑃 ) = 4.9173 = P1,016.82 (constant all throughout)
, 6%, 6
𝐴
where: nxm = 3 x 2 (semiannually) = 6 interest periods
12%
i= = 6%
2
Principal repaid at the end of period = Payment – Interest

= P 1016.82 – P300
Principal repaid at the end of period = P 716.82
Period 2. Outstanding principal at beginning of period = column 1 – column 4

= P5000 – P 716.82
Outstanding principal at beginning of period = P4,283.18
6 𝑚𝑜.
Interest due at the end of period = Pin = (P4,283.18)(0.12)( ) = P 256.99
12 𝑚𝑜.
𝑃 𝑃5000
Payment = A = 𝑃 ( ) = 4.9173 = P1,016.82 (constant all throughout)
,6%,6
𝐴
where: nxm = 3 x 2 (semiannually) = 6 interest periods
12%
i= = 6%
2
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Principal repaid at the end of period = Payment – Interest

= P 1016.82 – P256.99
Principal repaid at the end of period = P 759.82
Example 2. A debt of P10,000 with interest at the rate of 20% compounded semiannually is to be
amortized by 5 equal payments at the end of each 6 months, the first payment is to be made after 3
years. Find the semiannually payments and construct an amortization schedule.
1 2 3 4
principal at the end of at the end of
1 P 10,000 P1000.00
2 P11,000 P1100.00
3 P12,100 P1210.00
4 P13,310 P1331.00
5 P14,641 P1464.00
6 P16,105.10 P1610.51 P4,248.50 P2,637.99
7 P13, 467.11 P1346.71 P4,248.50 P2,901.79
8 P10,565.32 P1056.53 P4,248.50 P3,191.97
9 P7,373.35 P737.34 P4,248.50 P3,511.16
10 P3,862.19 P386.22 P4,248.50 P3,862.28
Total P11,242.41 P21,242.50 P16,105.19
(**** Same procedure just like in example 1***)
3.5. Uniform Gradient Series

Some economic analysis problems involve receipts or expenses that are projected to increase or
decrease by a uniform amount each period, thus constituting an arithmetic or geometric sequence of
cash flows. This situation can be modeled with a uniform gradient.
Types of Uniform Gradient

3.5.1. Uniform Arithmetic Gradient Series
An arithmetic gradient is one wherein the cash flow changes (increase or decrease) by
the same amount in cash flow period. The cash flow whether the income or disbursement changes
the same constant amount each period.
𝑮 (𝟏+ 𝒊)𝒏 −𝟏 𝟏
PG = ( − 𝒏) ((𝟏+ 𝒊)𝒏 ) Notation: G(P/G, i%, n)
𝒊 𝒊
PT = PA + PG
PT = A(P/A, i%,n) + G(P/G, i%, n)
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Example 1. The present worth of $400 in year 1 and amounts increasing by $30 per year through 5 at
an interest rate of 12% per year is closest to:
Solution:
PT = $400 (P/A, 12%, 5) + $30 (P/G, 12%, 5)

= 400 (3.6048) + 30 (6.3970)
PT = $ 1,633.83
The cash flow could be converted into an A value as follows:

A = $400 + $30 (P/G, 12%, 5)
= $400 + $30 (1.7746)
A = $453.24
3.5.2. Uniform Geometric Gradient Series

A geometric gradient is common for cash flow series such as operating cost, construction
cost, and revenues to increase or decrease from period to period by a constant percentage.
𝒈 𝒏
𝟏 −(𝟏+ )
Pg = A ( 𝟏+𝒊
) g is not equal to i
𝒊−𝒈
𝑨𝟏 𝒏
Pg = g is equal to i
𝟏+𝒊
where:
P = present of all cash flow between 1 and n
A = cash flow in period 1
g = rate of change per period
i = effective interest rate per period
IM No.2:ENGG04-1S-2021-2022
Example 2. Find the present worth of $1000 in year 1 and amounts increasing by 7% per year through
year 10. Use an interest rate of 12% per year.
Solution:
0.07 10
1 −(1+ )
Pg = $1000 (
1+0.12
) where g = 7% and i = 12%
0.12−0.07
Pg = $ 7,333.00
3.6. Depreciation
Depreciation is the decrease in the value of physical property with the passage of time.
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 property.
Types of Depreciation:
1. Normal 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 centers 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
contents.
Physical and Economic Life

a. Physical life of a property is the length of time during which it is capable of performing the
function for which it was designed and manufactured.
b. Economic life is the length of time during which the property may be operated at a profit.
Requirements of a Depreciated 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 (BIR)
IM No.2:ENGG04-1S-2021-2022
Depreciation Methods
We shall use the following symbols for the different depreciation methods.
L = useful life of the property in years

C0 = the original cost
CL = the value at the end of the life, the scrap value (including gain or loss due to removal)
d = the annual cost of depreciation
Cn = the book value at the end of n years
Dn = depreciation up to age n years
3.6.1. The Straight Line Method (SLM)

This method assumes that the loss in value is directly proportional to the age of the
property.
𝑪𝟎− 𝑪𝑳
d=
𝑳
𝒏(𝑪𝟎− 𝑪𝑳)
𝑫𝒏 =
𝑳
Cn = C0 - Dn
3.6.2. The Sinking Fund Formula (SFF)
This method assumes that a sinking fund is established in which funds will accumulate for
replacement. The total depreciation that has taken place up to any given time is assured to be
equal to the accumulated amount in the sinking fund at that time.
Dn C0 – CL
0 1 2 3 n L
d d d d d
d= 𝑭
,𝒊%,𝑳
𝑨
Dn = d (F/A, i%, n)
C0 = C0 - Dn
3.6.3. Declining Balance Method (DBM)

In this method sometimes called the constant percentage method or the Matheson
Formula is assumed that the annual cost of depreciation is a fixed percentage of the salvage
IM No.2:ENGG04-1S-2021-2022
value at the beginning of the year. The ratio of the depreciation in any year to the book value of
the beginning of that year is constant throughout the life of the property and is designated by k,
the rate of depreciation.
C0 C1 C2 C3 Cn-1 Cn CL-1 CL
0 1 2 3 n–1 n–1 L–1 L
d1 d2 d3 dn dL
where: dn = depreciation during the nth year
Year Book value at the beginning of Depreciation during Book value at the end
year the year of year
1 C0 d1 = kC0 C1 = C0 – d1 = C0(1 – k)
2 C0(1 – k) d2 = kC1 C2 = C0 – d2 = C0(1 – k)2
3 C0(1 – k)2 d3 = kC3 C3 = C0 – d3 = C0(1 – k)3
n C0(1 – k)n-1 dn = kCn-1 Cn = C0 – dn = C0(1 – k)n
L C0(1 – k)L-1 dL = kCL-1 CL = C0 – dL = C0(1 – k)L
dn = C0(1 – k)n-1k
𝒏
𝑪
Cn = C0(1 – k)n = C0(𝑪𝑳 )𝑳
𝟎
CL = C0(1 – k)L
𝒏 𝑪 𝑳 𝑪
k = 1 - √𝑪𝒏 = 1 - √𝑪𝒏
𝟎 𝟎
This method does not apply if the salvage value is zero because k will be equal to one and d1 will
be equal to C0
3.6.4. 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.
𝟐 𝟐
dn = C0(1 – 𝑳)n-1 𝑳
𝟐
Cn = C0(1 – 𝑳)n
𝟐
CL = C0(1 – 𝑳)L
When the DDB method is used, the salvage value should not be subtracted from the first
cost when calculated the depreciation charge.
IM No.2:ENGG04-1S-2021-2022
3.6.5. The Sum of the Years Digits (SYD) Method

Let: dn = depreciation charge during the nth year
dn = (depreciation factor)(total depreciation)
𝒓𝒆𝒗𝒆𝒓𝒔𝒆 𝒅𝒊𝒈𝒊𝒕
dn = 𝒔𝒖𝒎 𝒐𝒇 𝒅𝒊𝒈𝒊𝒕𝒔 (C0 – CL)
3.6.6. 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 that time. This method has the advantage
of making the unit cost of depreciation constant and giving low depreciation expense 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 =
𝑻
dn = (Qn)
𝑻
Sample Problems:
Example 1. A machine costs P7,000 last 8 years and has a salvage value at the end of life of P350.
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
d. sinking fund method with interest of 12%
Solution:
C0 = P7,000 CL = P350 L = 8 years n=4
a. By straight line method
𝐶0− 𝐶𝐿 𝑃7000−𝑃350
d= = = P831
𝐿 8
C4 = C0 – D4 = P7000 – P831(4) = P3,676
b. By declining balance method
𝐿 𝐶 8 𝑃350
k = 1 - √ 𝐶𝑛 = 1 - √𝑃7000 = 0.3123
0
d4 = C0 ( 1 – k)n-1 k = P7000 ( 1 – 0.3123)4-1 (0.3123) = P711
C4 = C0 ( 1- k)n = P7000 (1 – 0.3123)4 = P1,566
IM No.2:ENGG04-1S-2021-2022
c. SYD method
Year Reverse Year

1 8
2 7
3 6
4 5
5 26
6
7
8
36
𝒓𝒆𝒗𝒆𝒓𝒔𝒆 𝒅𝒊𝒈𝒊𝒕 𝟖(𝟖+𝟏)
Sum of digits = 𝒔𝒖𝒎 𝒐𝒇 𝒅𝒊𝒈𝒊𝒕𝒔 = = 36
𝟐
𝑟𝑒𝑣𝑒𝑟𝑠𝑒 𝑑𝑖𝑔𝑖𝑡 5
d4 = 𝑠𝑢𝑚 𝑜𝑓 𝑑𝑖𝑔𝑖𝑡𝑠 (C0 – CL) = 36 (P7000 – P350) = P924
𝑟𝑒𝑣𝑒𝑟𝑠𝑒 𝑑𝑖𝑔𝑖𝑡 26
D4 = 𝑠𝑢𝑚 𝑜𝑓 𝑑𝑖𝑔𝑖𝑡𝑠 (C0 – CL) = 36 (P7000 – P350) = P4,803
C4 = C0 – D4 = P7000 – P4803 = P2,197
d. By sinking fund method

𝐶0− 𝐶𝐿 𝑃7000−𝑃350
d= 𝐹 = = P541
,𝑖%,𝐿 12.2997
𝐴
Dn = d (F/A, i%, n) = P541(4.7793) = P2,586
C0 = C0 - Dn = P7000 – P2586 = P 4,414
Example 2. L.G. Company purchased machinery for P100,000 on July 1, 2000. It is estimated that it will
have a useful life of 10 years; scrap value of P4000, production of 400,000 units and working hours of
120,000. The company uses the machinery for 14,000 hours in 2000 and 18,000 hours 2001. The
machinery produces 36,000 units in 2000 and 44,000 units in 2001. Compute the depreciation for 2001
using each method given below:
a. straight line
b. working hours
c. output method
Solution:
C0 = P100,000 CL = P4000 L = 10 years

T = 400,000 units H = 120,000 hours
𝐶0− 𝐶𝐿 𝑃100,000−𝑃4,000
a. d2001 = = = P9,600
𝐿 10
𝐶0− 𝐶𝐿 𝑃100,000−𝑃4,000
b. d2001 = ( )𝐻80 = (18,000) = P14,000
𝐻 120,000
𝐶0− 𝐶𝐿 𝑃100,000−𝑃4,000
c. d2001 = ( )𝑄80 = (44,000) = P10,560
𝑇 400,000
IM No.2:ENGG04-1S-2021-2022
VI. LEARNING ACTIVITIES
NAME: _________________________ SCHEDULE: __________

COURSE & YEAR: _______________ DATE: ____________
ACTIVITY 2
Problem. Solve the following problems systematically and neatly. Enclose all final answers in a box.
1. Shane Kyle had a loan of $1 M that is paid off quarterly over a period of nine years. Calculate the dollar
amount of interest and loan principal repaid corresponding to each payment if the interest rate is 6% per
year compounded quarterly. Prepare an amortization schedule.
1 2 3 4
(Quarterly) principal at the end of at the end of
2. An industrial plant bought a generator set for P90,000. Other expenses including installation amounting
to P10,000. The generator set is to have life of 17 years with a salvage value at the end of life of P5000.
Determine the depreciation charge during the 13th year and the book value at the end of 13 years by:
a. declining balance method
b. double declining method
c. sinking fund method at 12%
d. SYD method
IM No.2:ENGG04-1S-2021-2022
VII. EVALUATION (Note: Not to be included in the student’s copy of the IM)
VIII. ASSIGNMENT
NAME: __________________________ SCORE: ______________

COURSE & YEAR: _________________ DATE: _______________
ASSIGNMENT 2
Direction: Solve the following problems systematically. Enclose all answers in a box.
1. A loan of P2000 is made for a period of 13 months from January 1 to January 31 the following year at
a simple interest rate of 20%. What future amount is due at the end of the loan period?
2. What will be the future worth of money after 14 months if a sum of P10,000 is invested today at a
simple interest rate of 12% per year?
3. If you borrow money from your friend with simple interest of 12%, find the present worth of P20,000
which is due at the end of nine months.
4. If P1000 becomes P5,743 after 15 years when invested at an unknown rate of interest compounded
semiannually, determine the unknown nominal rate and the corresponding effective rate.
5. Find the present worth of a future payment of P100,000 to be made in 5 years with an interest rate of
10% compounded annually.
6. A man wishes his son to receive P200,000 ten years from now. What amount should he invest now if
it will earn interest of 10% compounded annually during the first 5 years and 12% compounded quarterly
during the next 5 years?
7. Mr. Reyes borrows P60,000 at 12% compounded annually agreeing to repay the loan in 15 equal
annual payments. How much of the original principal is till unpaid after he has made the 8th payment?
8. Mr. J. Dela Cruz borrowed money from a bank. He received from the bank P1,342 and promised to
repay P1,500.00 at the end of 9 months. Determine the following:
a. simple interest rate
b. the corresponding discount rate or also known as the “Banker’s discount”
9. A man inherited a regular endowment of P100,000 every end of 3 months for 10 years. However, he
may choose to get a single lump sum payment at the end of 4 years. How much is this lump sum if the
cost of money is 14% compounded quarterly?
10. The maintenance cost of a sewing machine this year is expected to be P500, the cost will increase
P50 each year for the subsequent 9 years. The interest is 8% compounded annually. What is the
approximate present worth if maintenance for the machine over the full 10 year period?
IM No.2:ENGG04-1S-2021-2022
IX. REFERENCES
A) Book/Printed Resources
De Garmo, EP. (1988). Engineering Economy, 8th Edition. Macmillan Publishing Company.
Park, C.S. (2013). Engineering Economics, 3rd Edition. Pearson Education, Inc.
Sta. Maria, Hipolito (1993). Engineering Economy, 2nd Edition. National Book Store.
B) e-Resources
Engineering Economy. Retrieved from https://www.EngineeringBookspdf.com
Engineering Economy. Retrieved from https://www.youtube.com/watch?v=zpZGq1rTWEU&list

=PLvJR-crn9YFxZ_kvKXJr7_QVkPbs81qUj&index=4
Engineering Economy Module 1: Introduction. Retrieved from https://www.youtube.com/watch?

v=cxZX5myCeMA.
Introduction to Engineering Economy. Retrieved from https://www.youtube.com/watch?v=2AhYE-

AY1AM.
Principles of Economics. Retrieved from https://opentextbc.ca/principlesofeconomics/
Slide Share. Retrieved from https://www.slideshare.net/ltpham18/lecture-4-gradients-factors-

and-nominal-and-effective-interest-rates

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Republic of the Philippines

NUEVA VIZCAYA STATE UNIVERSITY

College : COLLEGE OF ENGINEERING

DEGREE PROGRAM Bachelor of COURSE NO. ENG’G 04

I. UNIT TITLE/CHAPTER TITLE:

CHAPTER 2. MONEY TIME RELATIONSHIPS AND EQUIVALENCE

II. LESSON TITLE:

1. Interest and Time Value of Money

III. LESSON OVERVIEW

IV. DESIRED LEARNING OUTCOMES

MONEY TIME RELATIONSHIPS AND EQUIVALENCE

1. INTEREST AND TIME VALUE OF MONEY

Two Classifications of Simple Interest

1 interest period = 365 or 366 days

Test for leap year = divisible by four

Month of the Year No. of days

Interest Principal at Beginning Interest Earned Amount at End of Period

Therefore, the formula for compound interest is:

F = P (1 + i)n or in its notation F = P(F/P, i%, n) ---→ future worth

Example 3. A chemical engineer wished to accumulate a total of P10,000.00 in a savings account

Solution: Since it is compounded quarterly

Solution: Since it is compounded quarterly

1.3. RATES OF INTEREST

Let: r = the unknown nominal rate

Nominal Rate Effective Rate

r = 12.12% compounded quarterly

Thus, 12% compounded monthly is equivalent to 12.12% compounded quarterly.

receipt (positive cash flow or cash inflow)

disbursement (negative cash flow or cash outflow)

2.1. Viewpoint of a Lender

2.2. Viewpoint of a Borrower

3. THE CONCEPT OF EQUIVALENCE

3.1. The Equation Value

Solution: Cash flows going to present

Let Q = the final payment

Using today @ t = 0 , the equation of value is:

P 800,000 = P 300,000 (P/F, 20%, 1) + P400,000 (P/F, 20%, 3) + Q (P/F, 20%, 5)

Another Solution: Cash flows going to future

Let Q = the final payment

P 800,000 (F/P, 20%, 5) = P 300,000 (F/P, 20%, 4) + P400,000 (P/F, 20%, 2) + Q

d = 1 – 0.80 = 0.20 or 20%

c. rate of interest for one year

Symbols and their meaning:

3.3.1. Ordinary Annuity

The formulas for ordinary annuity are the following:

P P 10,000 (F/A, 15%, 10)

P 10,000 (P/A, 15%, 10)

For annual cash flow:

For semiannual cash flow:

Period = 20 x 2 = 40 interest periods

A(F/A, 4%, 40)

For the withdrawals, i = (1 + 0.04)2 - 1 = 0.0816 8.16%

3.3.2. Deferred Annuity

A(P/A, 14%,8)(P/F,14%,9) A(P/A, 14%,8)

10K 10K 10K 10K 10K

P 10,000 (P/A, 14%, 9)

Using today (@ t = 0) as the focal date, the equation of value is:

10K 10K 10K 10K 10K

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

10K 10K 10K 10K 10K Deferred Part

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

P40K(P/A,15%,6)(P/F,15%,6) P40K(P/A,15%,6) P50K P50K

P30K(P/A,15%,6) P40K P40K P40K

(** Same procedure just like in example 1*)

NAME: _______________ SCHEDULE:

NAME: ____________ SCORE: