Engineering

Economy
SY 2020-21
UNIT 2
 Time and
Money
Relationship
 • Identify the different types of interest and
terminologies used;
• Compute for interest, present value, future
value, and discount;
• Understand inflation and its effect;
Objective • Comprehend and familiarize the use of cash
flow diagrams;
• Comprehend the concepts of annuity; and
• Apply the concepts of annuity in evaluating
engineering decisions.
Interest and the Time
Value of Money
Money

• Medium of Exchange
• Unit of Account
• Power Over Time
 • The percentage of borrowed money that is
paid to the lender on some time basis
• Justified from a lender’s perspective in view
Interest Rate of:
• Opportunity cost
• Risk of Lending
 Simple Interest
•• The
  total interest earned or charged is linearly
proportional to the initial amount of the loan (principal),
the interest rate and the number of interest periods for
which the principal is committed.

, where

P = principal amount lent or borrowed

n = number of interest periods (e.g. years)
i = interest rate per interest period
 Simple Interest
•• The
  accumulated amount or future worth is equal to:
 Simple Interest

• Ordinary Simple Interest • Exact Simple Interest

• Computed based on 12 • Based on the exact number of
months of 30 days each or days in a year, 365 days for
360 days a year an ordinary year, while 366
days for a leap year
 Simple Interest
Determine the interest of a ₱75,000 loan borrowed from
January 1, 2018 until September 16, 2018 at rate of interest
of 15% per annum. Compute based on ordinary and exact
interests.

ORDINARY
Jan 1 – Sept 16 = 8 + (15/30) = 8.5 months
I = Pni
I = 75,000 (8.5/12) (0.15)
I = ₱7,968.75
Jan 1 – Sept 16 = 8 (30) + 15 = 255 days
I = Pni
I = 75,000 (255/360) (0.15)
I = ₱7,968.75
 Simple Interest
Determine the interest of a ₱75,000 loan borrowed from
January 1, 2018 until September 16, 2018 at rate of interest
of 15% per annum. Compute based on ordinary and exact
interests.

EXACT
Jan1-31 = 30 days
(excluding Jan1)
Feb1-28 = 28
I = Pni
Mar1-31 = 31 I = 75,000 (258/365) (0.15)
Apr1-30 = 30 I = ₱ 7,952.05
May1-31 = 31
Jun1-30 = 30
July1-31 = 31
Aug1-31 = 31
Sep1-16 = 16
 Compound Interest
• Interest charge for any interest period is
based on the remaining principal amount
plus any accumulated interest charges up
to the beginning of that period
• Interest on top of an interest
 Compound Interest

Principal Interest
Interest
Beg. Earned Amount of End Period
Period
Period During Period

1 P Pi P+Pi= P(1+i)
2
2 P(1+i) P(1+i)(i) P(1+i)+P(1+i)(i)= P(1+i)
3 P(1+i)2 P(1+i)2 (i) P(1+i)2 +
P(1+i)2 (i) = P(1+i)3
--- --- --- --- ---
n-1 n-1 + n-1 n
n P(1+i) P(1+i)n-1 (i) P(1+i) P(1+i) (i) = P(1+i)
 Compound Interest
If a friend borrowed ₱1,000 from you at a rate of
10% compounded annually, how much would be
the future values at the end of 2nd year and 3rd
year?
 Compound Interest
Interest Earned
Interest Principal Beg.
During Period Amount of End Period
Period Period
@10%
1 1,000.00 100 1,100.00
2 1,100.00 110 1,210.00
3 1,210.00 121 1,331.00

F2 = P (1+I)n F3 = P (1+I)n
= 1,000 (1+.10)2 = 1,000 (1+.10)3
F2 = 1,210 F3 = 1,331
 Compound Interest : Nominal
• “indicative”
  rate per annum and the number of
interest periods in one year
, where
i = rate of interest per interest period
r = nominal interest rate
m = number of compounding periods per year
• Examples:
• 12% compounded quarterly means i=3% per quarter
• 15% compounded semi-annually means i=7.5% per
semester
• 24% compounded monthly means i=2% per month
 Compound Interest : Nominal
•  r = nominal rate of interest per year
m = number of interest periods per year
mn =number of interest periods in n years
= rate of interest per interest period
 Compound Interest : Nominal
What is the future worth of ₱600 after 4
years if the interest rate is 12%
compounded quarterly?
 Compound Interest : Effective
• The actual rate of interest on the principal for
one year
• Effective is equal to nominal if compounded
annually
• Effective is greater if there are more than one
interest period in one year
 Compound Interest : Effective
•₱25
  invested at 10% compounded quarterly.
 Compound Interest : Effective

• 
Continuous
Compounding
•  When the number of interest periods
per year increases without limit
Interest
• If ₱100,000 is invested at 12% compounded annually, determine how
many years it will take to double?
Interest
• Which is better for an investor, to invest at 5.5% compounded semi-
annually or 5% compounded monthly?
Discount
•  The difference between what it is worth in the future and its present
worth

• Rate of Discount – discount on one unit of principal per unit of time

Discount
Mr. Juan Santos borrowed money from ABC Bank. He received ₱1,342
and promised to repay ₱1,500 at the end of 9 months. Determine the
simple interest rate, the corresponding discount rate and equivalent
interest rate for one year.
Inflation
•  The annual increases in prices which decreases the purchasing power
of money
• Cost Projection of Commodity:

• Buying Power of Money:

Inflation
• If a steel bar costs ₱206 and prices increase at a rate of 5.5%, what
would be the equivalent price in 3 years?
Inflation
• If a resident has a budget of ₱2,500,000 today, how much would be its
worth given the economic condition of 5% in 4 years?
“ Character is doing the right
thing when nobody is looking.”
J.C. Watts