UNIVERSITY OF SOUTHERN MINDANAO

ENGINEERING ECONOMY
EngSci 19
 Basic Methods for Economy
Studies
• Rate of Return (ROR) Method:

Rate of return is a measure of the

effectiveness of an investment of capital. It
is a financial efficiency. When this method is
used, it is necessary to decide whether the
computed rate of return is sufficient to
justify the investment.

EngSci 19 – Engineering Economy 2

Rate of Return (ROR)
Method

𝑛𝑒𝑡 𝑎𝑛𝑛𝑢𝑎𝑙 𝑝𝑟𝑜𝑓𝑖𝑡

𝑅𝑎𝑡𝑒 𝑜𝑓 𝑅𝑒𝑡𝑢𝑟𝑛 =
𝑐𝑎𝑝𝑖𝑡𝑎𝑙 𝑖𝑛𝑣𝑒𝑠𝑡𝑒𝑑

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 Annual Worth (AW) Method
In this method, interest on the original
investment is included as a cost. If the
excess of annual cash inflows over annual
cash outflows is not less than zero the
proposed investment is justified or valid.
This method is covered by the same
limitations as the rate of return pattern a
single initial investment of capital and
uniform revenue and cost throughout the
life of the investment.
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 Present Worth (PW) Method
This pattern for economy studies is based
on the concept of present worth. If the
present worth of the net cash flows is
equal to, or greater than, zero, the project
is justified economically. The present worth
method is flexible and can be used for any
type of economy study. It is used
extensively in making economy studies in
the public works field, where long-live
structures are involved.
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 Future Worth (FW) Method
The future worth method for economy
studies is exactly comparable to the
present worth method except that all
cash inflows and outflows are
compounded forward to a reference
point in time called the future. If the
future worth of the net cash flows is
equal to, or greater than, zero, the
project is justified economically.
EngSci 19 – Engineering Economy 6
 Payback (Payout) Period
Method
The payback period is commonly defined as the
length of time required to recover the first cost of
an investment from the net cash flow produced by
that investment for an interest rate of zero.

𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 − 𝑠𝑎𝑙𝑣𝑎𝑔𝑒 𝑣𝑎𝑙𝑢𝑒

𝑃𝑎𝑦𝑜𝑢𝑡 𝑝𝑒𝑟𝑖𝑜𝑑 𝑦𝑒𝑎𝑟𝑠 =
𝑛𝑒𝑡 𝑎𝑛𝑛𝑢𝑎𝑙 𝑐𝑎𝑠ℎ 𝑓𝑙𝑜𝑤

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 Example:
An investment of ₱270,000 can be made in a
project that will produce a uniform annual revenue
of ₱185,400 for 5 years and then have a salvage
value of 10% of the investment. Out-of-pocket costs
for operation and maintenance will be ₱81,000 per
year. Taxes and insurance will be 4% of the first cost
per year. The company expects capital to earn not
less than 25% before income taxes. Is this a
desirable investment? What is the payback period
of the investment?

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 Example:
A businessman is considering building a 25-unit apartment
in a place near a progressive commercial center. He felt that
because of the location of the apartment it will be occupied
90% at all time. He desires a rate of return of 20%. Other
pertinent data are the following:

Land investment - ₱5,000,000

Building investment – ₱7,000,00
Study period – 20 years
Cost of land after 20 years – ₱20,000,000
Cost of building after 20 years – ₱2,000,000
Rent per unit per year – ₱6,000
Upkeep per unit per year – ₱500
Property taxes – 1%
Insurance – 0.50%
Is this a good investment?

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 Example:
A man is considering investing ₱500,000 to open a semi-
automatic auto-washing business in a city of 400,000
population. The equipment can wash, on the average, 12
cars per hour, using two men to operate it and to do small
amount of hand work. The man plans to hire two men, in
addition to himself, and operate the station on an 8-hour
basis, 6 days per week, 50 weeks per year. He will pay his
employess ₱25.00 per hour. He expects to charge ₱25.00
for a car wash. Out-of-pocket miscellaneous cost would be
₱8,500 per month.
He would pay his employees for 2 week for vacation each
year. Because of the length of his lease, he must write off
his investment within 5 years. His capital now is earning 15%
and he is employed at a steady job that pays ₱25,000 per
month. He desires a rate of return of at least 20% on his
investment. Would you recommend the investment?

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