Engr. Ninoel B.

Dela Cruz
Interest
It is the amount of money earned by a given capital.
Borrower’s viewpoint: Amount of money paid for the use
of a borrowed capital.
Lender’s viewpoint: Income generated by the capital that
was lent.
Cash Flow Diagram
Cash flow diagrams may be drawn to help visualize and
simplify problems having diverse receipts and disbursements.

PHP 1,000

1 2

PHP 540
PHP 580
Cash Flow Diagram
• The horizontal (time) axis is marked off in equal
increments, one per period up to the duration of the
project.
• All disbursement and receipts (cash flow) are assumed to
take place at the end of the year in which they occur. This
is known as the year-end convention. The exception is the
initial cost (purchase cost) which occur at t=0
• Two or more transfers in the same period placed end to
end may be combined into one.
• Receipts and disbursement are represented by arrows on
opposite sides of the horizontal time axis.
Cash Flow Diagram
Ex: An electronic equipment costs P30, 000. Maintenance cost
is P3, 000 per year. The device will generate revenues of
P15,000 each year for 5 years after which the salvage value is
expected to be P12,000. Draw and simplify the cash flow
diagram. P12T
P15T P15T P15T P15T P15T

P3T P3T P3T P3T P3T

P30T
Cash Flow Diagram
The simplified cash flow diagram is as follows:

P24T

P12T P12T P12T P12T

P30T
SIMPLE INTEREST
In simple interest, the interest earned by the principal is
computed at the end of the investment period, and thus, it
varies directly with time.

Ordinary Simple Interest

Exact Simple Interest
Ordinary Simple Interest
In ordinary simple interest, the interest is computed on the
basis of one banker’s year.
1 banker’s year = 12 months
(30 days each month) = 360 days
Exact Simple Interest
• In exact simple interest, the interest is based on the exact
number of days of the year, where there are 365 days for
an ordinary year and 366 days for leap years.
• Leap year occurs every 4 years. These are years that are
exactly divisible by four, except century marks (1800,
1900, etc.) but not including those that are exactly
divisible by 400 (2000, 2400, etc.)
Elements of Simple Interest
Elements of Simple Interest
• Value of t:

Example:
4 years; t = 4
3 months; t = 3/12 = ¼
90 days
Ordinary simple interest, t = 90/360
Exact simple interest, t = 90/365
Or 90/366 for leap years
2 years & 4 months;
t = 2 + 4/12 = 2.333
SAMPLE PROBLEMS FOR SIMPLE
INTEREST
Find the interest on P6800.00 for 3 years at 11% simple
interest.
SAMPLE PROBLEMS FOR SIMPLE
INTEREST
A man borrowed P10,000.00 from his friend and agrees to
pay at the end of 90 days under 8% simple interest rate.
What is the required amount?
SAMPLE PROBLEMS FOR SIMPLE
INTEREST
What is the principle amount if the amount of interest at
the end of 2½ year is P4500 for a simple interest of 6%
per annum?
SAMPLE PROBLEMS FOR SIMPLE
INTEREST
How long must a 40,000 note bearing 4% simple interest
run to amount to P41,350.00
COMPOUND INTEREST
• In compound interest, the interest is computed every end
of each interest period (compounding period), and the
interest earned for that period is added to the principal
(interest plus principal).
• To demonstrate these consider an investment of P1000 to
earn 10% per year for three years. The following diagram
shows how the money grows.
Elements of compound
interest
P = present worth or principal
F = future worth or compound amount
i = effective interest per compounding period (per interest period)
= r/m
n = total number of compounding
n=txm
I = interest earned
=F–P
r = nominal interest rate
ER = effective interest
t = number of years of investment
m = number of compounding per year
COMPOUND INTEREST
Values of i and n:
The values of i and n can be demonstrated from the following example:

Nominal interest rate, r = 12%

Number of years of investment, t = 5 years
Compounded annually (m = 1) Compounded quarterly (m = 4)
i = 0.12/1 = 0.12 i = 0.12/4 = 0.03
n = 5(1) = 5 n = 5(4) = 20
Compounded semi-annually (m = 2) Compounded monthly (m = 12)
i = 0.12/12 = 0.01
i = 0.12/2 = 0.06
n = 5(12) = 60
n = 5(2) = 10
Compounded bi-monthly (m = 6)
i = 0.12/6 = 0.02
n = 5(6) = 30
SAMPLE PROBLEMS FOR COMPOUND
INTEREST
Accumulate P5,000 for 10 years compounded (a)
quarterly (b) semi-annually (c) monthly (d) annually.
SAMPLE PROBLEMS FOR COMPOUND
INTEREST
How long will it take for an investment to double its
amount if invested at an interest rate of 6% compounded
bi-monthly?
Continuous compounding (m
→ ∞)
Nominal and effective rates of
interest
• Nominal rate is the rate quoted in describing a given
variety of compound interest. Consider a bank deposited
of P1000 to earn 6% compounded quarterly. After one
year, the compound amount F is:
F = P (1 + i)n
= 1000 (1 + 0.06/4)1 x 4
F = P1061.36
Effective rate
Effective rate (continuous)
Equivalent nominal rates
• Two nominal rates are equal if they have the same effective rate.
• Consider a nominal interest rate of 10% compounded quarterly.
The equivalent nominal rate compounded monthly is:

ERM = ERO
(1 + r/12)12 – 1 = (1 + 0.10/4)4 – 1
r = 0.09918 = 9.918%

• Thus, 10% compounded quarterly will have the same effect as

9.918% compounded monthly.
SAMPLE PROBLEMS FOR EFFECTIVE
RATE
What is the effective rate for an interest rate of 12%
compounded continuously?
SAMPLE PROBLEMS FOR EFFECTIVE
RATE
A bank offers 1.2% effective monthly interest. What is
the effective annual rate with monthly compounding?
ANNUITY
• Annuity is a series of uniform payments made at equal
intervals of time.
• Annuities are established for the following purposes:
1. As payment of a debt by a series of equal payment at
equal time intervals, also known as amortization.
2. To accumulate a certain amount in the future by
depositing equal amounts at equal time intervals. These
amounts are called sinking fund.
3. As a substitute periodic payment for a future lump sum
payment.
Elements of Annuity
A = periodic payment
P = present worth of all periodic payments
F or S = future worth or sum of all the periodic payments
after the last payment is made.
i = interest rate per payment
n = number of payments
Types of Annuity
Ordinary Annuity
Deferred Annuity
Annuity Due
Perpetuity
Types of annuity
Ordinary annuity
In ordinary annuity, the payment is made at the end of each
period starting from the first period, as the diagram shown
below:
0 1 2 3 4 n

A A A A A
F
P
Ordinary Annuity
Ordinary Annuity
Ordinary Annuity
Ordinary Annuity
SAMPLE PROBLEMS FOR ORDINARY
ANNUITY
If money is worth 4% compounded monthly, what
payment at the end of each quarter will replace
payments of P500.00 monthly?
SAMPLE PROBLEMS FOR ORDINARY
ANNUITY
• What amount would have to be invested at the end of
each year for the next 8 years at 4% compounded
semi-annually in order to have P5,000 at the end of
the time?
Deferred Annuity
In this type, the first payment is deferred a certain
number of periods after the first.

0 1 2 3 4 5

A A A A
F
n =4
P’

P n=5
SAMPLE PROBLEM FOR DEFFERED
ANNUITY
A man borrowed P200,000 from a bank at 12% compounded
monthly, which is payable monthly for 10 years (120
payments). If the first payment is to be made after 3 months,
how much is the monthly payment?
Annuity Due
0 1 2 3 4 n

A A A A A A
F
n =6
P

n =5
SAMPLE PROBLEM FOR ANNUITY DUE
An avionics equipment cost P120,000 if paid in cash. The
equipment may also be purchased by installment to be paid
within 5 years. If money is worth 8%, determine the amount of
each annual payment, if all payments are made at the
beginning of each year.
Perpetuity
SAMPLE PROBLEM FOR PERPETUITY
If money is worth 8%, determine the present value of a
perpetuity of P1,000 payable annually, with the first payment
due at the end of 5 years.
SAMPLE PROBLEM FOR PERPETUITY
Find the present value in pesos, of a perpetuity of P15,000
payable semi-annually if the money is worth 8%, compounded
quarterly.
CAPITALIZED COST AND
ANNUAL COST
Capitalized cost is an application of perpetuity. The capitalized
cost of a project or structure is the sum of the first cost (FC)
and the present worth of all future payments and replacements
which is assumed to continue forever.
If a project requires first cost (FC), annual operation and
maintenance (OM) for n years, a salvage value (SV) after
every n years, and replenishment cost (RC) after every
end of n years, then the capitalized cost (K) is:
Capitalized cost, K
RC may be taken as equal to FC if not specified in the
problem.

Capitalized cost may also be defined as the first cost plus

the present worth of annual maintenance and operation
cost plus the present worth of depreciation assumed to
continue forever.
The annual cost of a project is then:
Annual cost, AC = Ki

or AC = Annual interest on investment + Annual operation

and maintenance + Annual depreciation cost
Example
A machine costs P300,000 new, and must be replaced at the
end of each 15 years. If the annual maintenance required is
P5,000.00 find the capitalized cost, if money is worth 5% and
the final salvage value is P50,000
SAMPLE PROBLEMS FOR
CAPITALIZED COST
An item is purchased for P100,000. Annual costs are
P18,000. Using 18%, what is the capitalized cost of
perpetual service?
DEPRECIATION
Depreciation is the decrease in the value of an asset,
due to usage of passage of time. An asset may
depreciate physically or functionally.
 Elements of depreciation

 FC = First Cost
 SV = Salvage Value
 d = depreciation charge
 n = life of the property in years
 m = anytime before n
 BVm = Book Value after m years
 Dm = total depreciation for m years
The following diagram shows the cost of the property
plotted against time
Cost m

Dm
Cost Curve D
FC
BVm
SV

time

n
The book value at any time is:
Methods of computing
Depreciation
Straight Line Depreciation
It is assumed that the cost of property varies linearly with
time
Sinking Fund Method
Sum of the Years Digit Method (SOYD)
Declining Balance method (Constant percentage)
Double declining Balance Method
SAMPLE PROBLEMS FOR
DEPRECIATION
What is the value of an asset after 8 years of use if it
depreciates from its original value of P120,000 to its
salvage value of 3% in 12 years?
SAMPLE PROBLEMS FOR
DEPRECIATION
A man bought an equipment which cost P524,000.
Freight and installation expenses cost him P31,000. If
the life of the equipment is 15 years with an estimated
salvage value of P120,000, find its book value after 8
years.