ENGINEERING ECONOMY SUMMARY 2019

1) Principal (P) : initial amount of money present value of money or present

worth of money
2) Future Amount(F) : future amount of money future worth or future value
of the money
3) Series equal payment /receipt(A): uniformequal payment or receipt that
continoues N periods A1=A2=A3=An
4) Number of interest periods (N): Total number of interest periods mostly
in annual percentage
5) Interest Rate (i): Interest rate per N periods
6) Interest(I):Interest earned after N periods

EXAMPLE

Determine the interest symbols

John borrowed $5000 to purchase a construction material for building a new
house he can repay the loan in either of two ways

 Five equal annual installments with interest rate of 5% per year

 One payment of three(3)years from now with interest rate of 7% per year.
Determine the interest symbols and the value of both ways.

OPTION 1 OPTION 2
P = $ 5000 P = $ 5000
I = 5% I = 7%
N = 5 years N = 3years
A =? F=?

INTEREST CALCULATION

1) Simple Interest ( first principal interest )

2) Compound Interest (interest + interest )

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1) SIMPLE –INTEREST

Example : suppose you borrowed $ 7500 from a bank with annual I = P*i*N

F = P*I
interest rate of 8% calculate the future amount if you should repay
F = P+P*i*N
the loan in 4 years.
F = p(1+ i*N)
SOLUTION
F = p(1+ i*N)

F= $7500(1+0.08*4)

F= $ 9900.

N P I= (P*i) F =(P+I)
1 $7500 $600 $8100
2 $8100 $600 $8700
3 $8700 $600 $9300
4 $9300 $600 $9900

2) COMPOUND –INTEREST

Example:

Suppose you deposited $ 700 a bank at 7% of annual interest you plan to

withdraw the the principal and the interest after 3 years .Calculate the future
amount of this money.

SOLUTION

N P I=(P*i) F=(P+I)
1 $700 $49 $749
2 $749 $52.43 $801.4
3 $801.4 $56.1 $857.53

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CHANGE –IN-INTEREST

DI= P{ ( - (1+i*N)}

DI= $650{ ( - (1+(0.1)*(5))}

$71.5

ECONOMIC EQUIVALENCE

F= P(

Example

suppose you are offered an alternative of $ 3000 after 5 years or P dollor now you
have no current need of the money if you get the money now you would deposit
in an account that pays 8% annual interest what value of P dollor you get now
would make you economically indifferent a $3000 after 5 years.?

SOLUTION

F = $ 3000 I = 8% n = 5 years P=?

$2024.2

PRINCIPLES OF ECONOMIC EQUIVALENCE

 There must be common time basis(N)

 Interest rate should not vary during the interest period (I)
 Equivalence is maintained regard-less of point of view
 Equivalence calculation require conversion or multiple payments to single
payment .Multiple payment and single payments must be economically
equivalent.

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Example

Suppose you borrow $ 1000 from a bank for three (3) years at 10% annual interest
.The bank offeres two ways of repayment
1) End of year repayment of interest and principle repayment at the end of the
loam
2) One end of loam repayment of both the principle and the interest.
Determine whether the two options are economically equivalent.?
SOLUTION

Option 1 i= p * i Option 2
1000*0.1= $100
Yr1 $ 100 100( =$121
Yr2 $ 100 100( =$ 110
Yr3 $ 100 100( = $ 100
Yrn $ 1000 1000+121+110+100
Tot : $ 1300 $ 1331

4 TYPES OF CASH-FLOW

 SINGLE-CASH-FLOW: Involves equivalence of single present amount

and single future amount.
 EQUAL-SERIES-CASH-FLOW: Involves transactions arranged in series
payment /receipt.
 GRADIENT-SERIES-CASH-FLOW: Cash-flow not usually uniform but
increase or decrease by a constant amount.
 IRREGULAR-(MIXED)-SERIES: These cash-flows does not exhibit a
regular pattern each value is required as a principle or recognized as a
principle or future amount depending on what value is carsed.

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Example

Suppose you deposit $120 in a bank account that pays 10% annual interest .
How much will you get after 3 years.
SOLUTION

P = $120 I = 10% N=3 F= ?

$120(1.3310) $160

Irregular-Series-Cash-flow

Example
A growing machines shop wishes to set a side money now to invest over the next
4 years for it’s customer service department the company can earn 10% on
lupsum deposit now.The company wishes to withdraw the money in the following
increament
Year1 = $2500 Year 2 = $3000 Year 3 = No expense Year 4 = $5000
How much money must be deposit now to cover anticipated payment of the next
4 years.?
SOLUTION

GIVEN F1=$2500 F2=$3000 F4=$5000 P=? i=10%

P = P of F1 + P of F2+P of F4

2500(p/f 10% *1)+3000(p/f 10% *2)+5000(p/f 10%*4)

2500(0.9091)+3000(0.8264)+5000(0.6830) $ 28622

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N P F(10% )(0.1) WITHDRAW
1 $28622 $28622*1.1 =$31484 $2500
2 $6484 $6484*1.1 = $7133 $3000
3 $4133 $4133*1.1 = $4546 $--------
4 $4546 $4546*1.1 = $5000 $5000

Example

Suppose you deposit $1200 at the beginning of year 1 at an account that pays 7%
annual interest you deposited $1000 $500 $750 at the beginning of year
2,3and 5 respectively. How much money you get at the end of year 5.?
SOLUTION

GIVEN P 1 = $1200 P 2 = $1000 P 3 = $500 P 5 = $750 F=?

F = P of F1 + P of F2+P of F3+P of F5

1200(p/f 7% *5)+1000 (p/f 7% 42)+500(p/f 7%*3)+ 750(p/f 7%*1)

1200(1.4026)+1000(1.3108)+500(1.2250)+750(1.07) $ 4408.87

N P+D F
1
$1,200 $1200*(1.07) = $1284

2 $1284+$1000 = $ 2284 $2284 *( 1.7) = $2443.88

3 $2443.88+$500= $2943.88 $2943.88 *(1.07) = $3149.95

4 $3,149.95 $3149.95*(1.07) = $3370.44

5 $3370.44+$750 = $4120.44 $4120.44*(1.07) = $4408.84

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EQUAL-PAYMENT-SERIES

Find (F) given (A) amount

Example 1

Suppose you make annual contribution of $3000 to your saving account at the end
of each year for ten years .If the account pays 7% annual interest .How much can
be withdraw at the end of 10th year.?
SOLUTION

GIVEN F = A(F/A,I,N )
A = $3000 F=? F = 3000 ( F/A, 7%, 10 )
I = 7% F = 3000 (13.8164 )
N = 10 year $ 41449.2

N P+A
1 3000
2 3210 + 3000 = 6210
3 6644.7 + 3000 = 9644.7
4 10319.82 + 3000 = 13,319.82
5 14252.21 + 3000 = 17252.21
6 18459.8647 3000 = 21,459.86
7 22962.05 + 3000 = 25,962.05
8 27779.39 + 3000 = 30,779.39
9 32933..95 + 3000 = 35,933.95
10 38449.32 + 3000 = 41,449.32
F= (P*I)
(1.07)*3000 = 3210
(1.07)*6210 = 6644.7
(1.07)*9644.7 = 10,319.82
(1.07)*13,319.82 = 14,252.21
(1.07)*17,252.21 = 18,459.86
(1.07)*21,459.86 = 22,962.05
(1.07)*25,962.05 = 27,779.39
(1.07)*30,779.39 = 32,933.95
(1.07)*35,933.95 = 38,449.32
$ 41,449.32

Example 2

To get $ 5000 five years from now you plan to make five equal annual deposit at
the end of each year in an account that pays 7% annual interest . How much must
your annual deposit be .?

GIVEN A = F(A/F,I,N )
F = $5000 A=? A = 5000 ( A/F, 7%, 5 )
I = 7% A = 5000 (.0.1739 )
N = 5 year $ 869.5

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N P+A
1 $869.5
2 $930.36 + 869.5 = 1799.86
3 $1925.85 + 869.5 =2795.35
4 $2991.02 + 869.5 = 3860.52
5 $4130.76 + 869.5 = 5000
F ( P *I )
(1.07)* 869.5 = 930.36
(1.07)* 1799.86 = 1925.85
(1.07)* 2795.32 = 2991.02
(1.07)* 3860.52 = 4130.76
$ 5000

Example 3

Suppose you have been paying $2100 at the end of each year for 5 years to cover a
money you borrowed from a bank at 10% annual interest. How much money did
the bank lend you.?
SOLUTION

GIVEN
P=? P = A(P/A ,I,N )
A = $2100 $2100 (P/A,10%,5 )
N=5 $2100(3.7908)
I = 10% $ 7960.68

N P F(1.1)*P PAYMENT (A)

1 $7960.68 $8756.75 $2100
2 $6656.75 $7322.42 $2100
3 $5222.42 $5744.66 $2100
4 $3644.66 $4009.12 $2100
5 $1909.12 $2100 $2100

Example 4 (finding A given P )

Suppose a company barrows $20,000 from a bank at 10% annual interest the
company plans to pay back equal amount each year for the next 5 years. How
much equal amount must the company pay each year.?

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SOLUTION

GIVEN
A=? A= P(A/P ,I,N )
P = $20,000 $20,000 (A/P,10%,5 )
N=5 $20,000(0.2638)
I = 10% $ 5276

N P F(1.1)*P PAYMENT (A)

1 $20,000 $22,000 $5276
2 $16724 $18,396.4 $5276
3 $13120.4 $14,432.44 $5276
4 $9156.44 $10,072.08 $5276
5 $4796.08 $5276 $5276

GRADIENT-SERIES-CASH-FLOW

Example 1
A company purches a lift-truck that has use full life of five years,the engineer
estimates that maintainance cost during the first year will be $1000 as the truck
ages cost is expected to increase a constant amount of $250 per year .The firm
wants to set up a maintainance account that earns 12% annual interest .How
much should the firm deposit now in the account.?
SOLUTION

GIVEN A1 = $1000 G = $250 I = 12% N = 5 year P=?

P = P of A +Pof G

P = 1000(P/A ,I ,N) + 250(P/G, I ,N) P= 1000 (3.6048) + 250(6.3970)

P = 3604.8 + 1599.25 = $ 5204.05

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N CASH-FLOW P (12%)
1 $1000 $892.9
2 $1250 $996.5
3 $1500 $1067.7
4 $1750 $1112.125
5 $2000 $1134.8
TOTAL $ 5204.05

Example 2

Suppose you plan to deposit $250 in the first year at an account that pays 10%
annual interest you are planning to increase the deposit by $50 next five years
.How much do you get at the end of the 6th (sixth ) year .?
SOLUTION

GIVEN A1 = $250 G = $50 I = 10% N = 6 year F=?

F = F of A +Fof G

F = 250(F/A ,I ,N) + 50(F/G, I ,N)*(F/P,I,N) P= 250 (7.7156) +

50(9.6842)*(1.7716)

F = $ 2786.72

N CASH-FLOW
1 $250
2 $300
3 $350
4 $400
5 $450
6 $500
F
(1.6105)*(250) = $402.625
(1.1641)*(300) = $439.23
(1.3310)*(350) = $465.58
(1.2100)*(400) = $484
(1.10)*(450) = $495
(500) 500
TOTAL $2786.72

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WORK-SHEET

1) Suppose you want to get $5400 after 4-years .How much do you need to
deposit now in an account the pays 11% annual interest.?

2) Suppose you deposited $650 in an account that pays 10% annual interest
you plan to withdraw your money after five(5) years .Find out the future
amount in both simple and compound interest scheme ? Show the interest
and future of each year in a table.?

3) If you want to withdraw $1500,$340 and $670 in year 1,2,and 3 .How much
do you need to deposit in an account that pays 7% annual interest.?

4) Compute if these are economically equivalent if interest rate:

a. $4200 now and $4650 after 3 years.?
b. $7200 after 4 years and $6180 now .?
c. $1920 now and $4790 after 5 years.?
5) Suppose you deposited $7000 in an account that pays 10% annual interest
you want to withdraw same amount of money for 4 years .How much
money will be that equal withdraws for the 4 years.?
6) Suppose you would like to get $10,000 after five (5) years .How much same
amount of money must you deposit in an account that pays 10% annual
interest .?
7) Suppose you want to withdraw $300 in the first year and then increase the
withdrawal by $30 next 4 years from an account that pays 10% annual
interest .How much money do you need to deposit now to get that
withdrawals .? Assume that the above cash-flow is deposit and find at their
future amount.?

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