AMORTIZATION

- any method of repaying a debt, the principal and interest included, usually by a series of equal payments at
equal interval of time.
- Paying of debt with installments, where the installments can be either a series of equal payments or, more
commonly a calculated schedule of payments that includes accumulation of interest. The calculation
process is also often used to determine usage and depreciation of assets.

Illustrative Example:

1. A debt of P5,000 with interest at 6% payable quarterly will be discharged, interest

included, by equal payments at the end of each 3 months for two years. Construct the
amortization schedule.

Given:
P = P5,000 i = 6%/4 = 1.5% n = 4(2) = 8 quarters

Solution:

P=

5,000 = A

A = P667.92
Amortization Schedule

Period Principal at Interest at 1.5% Payment at end Periodic

beginning of each 3 per period of each period payment to
months principal
1 P5,000 P75.00 P667.92 P592.92
2 P4,407.08 P66.11 P667.92 P601.81
3 P3,805.27 P57.08 P667.92 P610.84
4 P3,194.43 P47.92 P667.92 P620.00
5 P2,574.43 P38.62 P667.92 P629.30
6 P1,945.13 P29.17 P667.92 P638.75
7 P1,306.38 P19.60 P667.92 P648.32
8 P658.06 P9.86 P667.92 P658.06
Totals P22,890.78 P343.36 P5,343.36 P5,000

The principal at the beginning of the first period is P5,000, which will earn interest equal
to P5,000(0.015) = P75.00. The amount available for repayment of principal is P667.92
 – P75.00 = P592.92. At the beginning of the second quarter the outstanding principal is
P592.92, which will earn interest of P592.92(0.015) = P66.11. Payment to principal is
P667.92-P66.11 = P601.81, and so on.
EQUIVALENT ANNUAL COST

The equivalent annual annuity approach is one of two methods used in capital budgeting to
compare mutually exclusive projects with unequal lives.

The equivalent annual cost method involves the following steps:

 Step 1 – Calculate the net present value (NPV) of cost for each potential replacement
cycle.
 Step 2 – For each potential replacement cycle an equivalent annual cost is calculated.
 The decision – The replacement cycle with the lowest equivalent annual cost may then
be chosen, although other factors may also have to be considered.

Illustrative Examples:
1. The maintenance cost of a certain equipment is P40,000 per year for the first 5 years,
P60,000 per year for the next 5 years, cost of overhaul at the end of the 5 th year and the 8th
year is P140,000. Find the equivalent uniform annual cost of maintenance if money is
worth 6% compounded annually.

Solution:
 ANOTHER SOLUTION: USING PRESENT WORTH

P1 = A = 40,000 = 168,494.55

P2 = A = 60,000 = 252,741.83

P3 = 252,741.83 (1.06)-5 = 188,863.39

P4 = 140,000 (1.06)-5 = 104,616.14
P5 = 140,000 (1.06)-8 = 87,837.73

Pt = 168,494.55+ 188,863.39+104,616.14+87,837.73 = 549,811.81

P=A

549,811.81= A
A = 74,701.81

2. A mechanical engineer is faced with the prospect of fluctuating future budget due to the
country’s economic condition for the maintenance of a particular machine. During each
of the five years P1,000 per year will be budgeted. During the second five years the
annual budget will be P1,500 per year. In addition, P3,500 will be budgeted for an
overhaul at the end of eight year. The mechanical engineer wonders what uniform annual
expenditures would be equivalent to these fluctuating amounts assuming compound
interest at 6% per annum. Compute the equivalent uniform annual expenditures for the 10

years period.

P=A = 1,000 = 4,212.36

P4 = 3,500 (1.06)-8 = 2,195.94

P2 = A = 1,500 = 6,318.55

P3 = 6,318.55(1.06)-5 = 4,721.59

Pt = 4,212.36 + 2,195.95 + 4,721.59 = 11,129.9

P=A
11,129.9= A

A = 1,512.20

3. A series of year and payment extending over 8 years are as follows: 10,000 for the 1 st year,
20,000 for the 2nd year, 50,000 for the 3 rd year and 40,000 for each year from the 4 th to the 8th
year. Find the equivalent annual worth of these payments if the annual interest is 8%.

F1 = = = 234,664.03

F2 = 50,000 (1.08)5 = 73,466.40

F3 = 20,000 (1.08)6 = 31,737.48

F4 = 10,000 (1.08)7 = 17,138.24

Ft = 234,664.03+ 73,466.40 + 31,737.48 + 17,138.24 = 357,006.16

=A

A = 33,563.85