CE 427 CMPM Lecture 7 Construction Economics

Construction Economics

It consists of the application of the techniques and expertise of

economics to the study of the construction firm, the construction
process and the construction industry.

Construction economics deals with study , but not limited to :

 Time Value of Money (simple and compound Interests

 Depreciation
 Total Owning and Operation Cost for Equipment

A.Time Value of Money:

Simple and Compound Interests
Interest is the cost of borrowing money, where the borrower pays a fee
to the lender for the loan.

Simple interest is an annual payment based on a percentage of the saved

or borrowed amount, also called the annual interest rate. Simple
interest grows based only on the money you deposit or invest (called
the principal).

A.1 Simple Interest Formula:

B=P(1 + r t)

Where B=Balance= Final amount at end of term

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Note :
Balance is the total amount in the account at the end of the term,
whose length is a time t in years.

I=Interest
P=Principal= initial amount loaned or borrowed
r=rate
t=time in years (length of the loan)

Simple Interest Calculation Example

Vicente Lao Construction Inc. takes out a P1,200,000 loan from BPI to buy a concrete

mixer. The loan has 4% interest, and a term of 24 months (2 years). How much

interest will the contractor pay on this loan?

Balance=?
Principal=1200 000
rate=.04=
time in years= 24 months =2 years

formula for Simple Interest:

B=P(1+rt)

B=1 200 000(1+.04(2))=1200 000(1.08)=1 296 000

Interest= B-P = 1 296 000- 1 200 000= P 96,000 (answer)

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Example 2
A construction loan was obtained from BPI amounting to P2,000,000 to build a new
building. The loan term is 3 years, and the interest rate is 5%. The interest is calculated
using the simple interest method. How much interest will be payed on this loan?

B=P(1+rt)

B=2 000 000(1+.05(3))= P 2,300,000

Interest paid = P 300,000 Answer

B. Compound Interest

Compound interest is interest earned not just based on the saved or borrowed amount,
but also on the interest already earned so far.

With compound interest, you earn based on the principal plus the interest you've
already earned.

nt
B(t) = P ( 1+r )
n
B= Final amount
P= Initial principal balance
r= Interest rate
n= Number of times interest is applied per time period (see table below)
t = time in years = Number of time periods elapsed

Note : “n” values

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 Number of times per year Interest is n value
calculated

Annually 1

Monthly 12

Weekly 52

Daily 365

Compound Interest Sample Calculation

Example 1 EEI contractors would like to purchase a dragline excavator for

river de-silting worth P 6,490 ,000. A Bank loan was approved for 4 % interest
rate compounded monthly. how much will EEI contractor owe the bank
after 2 years?

nt
B(t) = P ( 1+r )
n
We've shown that:

Balance=?
Principal= P 6 490 000
n= compounded monthly=12
rate=.04 (4%)
time in years=2 years

B(2) =6 490 000 (1+.04)12×2

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B(2)= P 7,029,598 at end of two years
Interest = P 7,029,598- P 6 490 000= P 539, 598 after two years (Answer)

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Example 2
A construction loan was obtained from BPI amounting to P2,000,000 to build a

new home. The loan term is 3 years, and the interest rate is 5% compounded

monthly . The interest is calculated using the Compound interest method. How

much interest will be payed on this loan?

nt
B(t) = P ( 1+r )
n

We've shown that:

Balance=?
Principal=2 000 000
n= monthly=12
rate=0.05 (5%)
time in years=3 years

B(3) =2 ,000, 000 (1+.05)12×3

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B(3) = P 2,322, 945

interest payed is P 322, 945 answer
(note, it is higher compared to simple interest calculation)

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C. Depreciation
Depreciation is an accounting method that spreads the cost of an asset
over its expected useful life to give a more accurate view of its value and
the business’s profitability.
Depreciation gives you a way to correlate the cost of an asset with its
usefulness, or ability to produce revenue, year over year.

Four Common Types of Depreciation calculation Method

 Straight line method
 Sum of the year’s digits
 Declining balance method
 IRS prescribed method

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C.1 Straight Line Method

Example 1

Note

Salvage value is the estimated book value of an asset after depreciation is

complete, based on what a company expects to receive in exchange for the
asset at the end of its useful life.

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C.2 Sum of the Years’ Digits method

Example Problem

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C.3 Double Declining Balance Method

Example problem

Note : Here N=5 or 5 years, using the formula,

Note :Use smaller value of D5 (1480 USD)

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C.4 IRS prescribed Method (MACRS)

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Source :https://www.calt.iastate.edu/taxplace/using-percentage-tables-calculate-depreciation

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Example

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Total Owning and Operation Cost for Equipment

To Calculate the Total Owning Cost:

Total Owning Cost= Depreciation + Cost Rate

But Cost Rate is given by the formula below

Cost Rate (%) = Investment + Tax + insurance + storage fee

Cost rate = cost rate (%) x Ave. Investment

hour Hours operated

The Formula for average Investment above is:

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NOTE :
For Fuel Cost use Table 17-1
For service Cost use Table 17-2
For repair Cost use Table 17-3
For tire Cost use Table 17-4

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Example 1 Estimated Hourly Repair Cost of Heavy Equipment

Answer

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Example 2 Total Owning and Operation Cost Calculation

Assume 2000 hours of operation

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