1st Semester 2020-2021

Engineering Economy

Course Outline

1. Interest and Money-Time Relationship

2. Depreciation
3. Capital Financing
4. Selections in Present Economy
5. Basic Methods for Making Economy Studies
6. Comparing Alternatives
7. Fixed, Increment, and Sunk Costs
8. Replacement Studies
9. Break-Even Analysis
10. Benefit/ Cost Ratio

Engineering Economy – is the analysis and evaluation of the factors that will affect the economic success of
engineering projects to the end that a recommendation can be made which will insure the best use of capital.

Consumer Goods & Services – are the products or services that are directly used by people to satisfy their wants.
Food, clothing, cars, shoes, medical and dental services are examples.

Producer Goods & Services – are used to produce consumer goods and services or other producer goods. Machine
tasks, generators, factory building, farm machinery, airplanes, buses, and ships are examples.

Demand – quantity of a certain commodity that is bought at a certain price at a given time and place.

Supply – quantity of a certain commodity that is offered for sale at a certain price at a given place and time.

Simple Interest

a. Ordinary Simple Interest – is computed on the basis of 12 months of 30 days each or 360 days a year.
b. Exact Simple Interest – is based on the exact number of days in a year, 365 days for an ordinary year and
366 days for leap year.
 I = interest Ls = Prt
I = Pni P = principal F = P + ls
Where: F = P + I = P + Pni N = number of interest periods F= P (1 + rt)
F = P (1 + ni) i = rate of interest per interest period

F = accumulated amount

Problems:

1. If ₱4000 borrowed at an annual interest rate of 16% has to be repaid in 6 months, find the interest and the
amount due.
2. If ₱5000 lent out at 15% annual interest earned ₱450 interest, how long has it been lent?

Solution:

1. ls = Prt = (4000)(0.16)(6/12) = 320.00

F = P + ls = 4000 + 320 = 4320.00
F = P (1 + rt) = 4000 [1 + 0.16(6/12)] = 4320.00
2. ls = Prt
t = ls/Pr = 450/(5000)(0.18) = 0.5 years or 6 months

Problem:

Using exact interest, determine the amount due on ₱14,000 borrowed for 130 days at 18.25% per year?

F = (P + ls) or P (1 + rt) = 14,000 [1 + 0.18259130/365)] = 14,000(1.065)

F = 14, 910.00

Procedure:

Find the remaining quantities for each of the items 1-5:

P r/year t ls F
1 2000 14.4% 8 months
2 17.4% 2 years 522.00
3 7200 210 days 554.20
4 5400 13.8% 1117.80
5 9600 0.115 2 ¾ years
6 1.5 years 787.50 4287.50
7 6800 0.156 8568.00
8 12 3/4% 948.28 9448.28

Cash-Flow Diagram

A cashflow diagram is simply a graphical representation of cash flow drawn on a time scale. Cashflow diagram for
economic analysis problems is analogous to that of free body diagram for mechanics problems.
 Receipts (positive cash flow or cash inflow)

Disbursement (negative cash flow or cash outflow)

Problem: A loan of ₱100 at simple interest of 10% will become ₱150 after 5 years.

1 2 3 4 150 Cash
Cashflow
flowdiagram
diagramononthe
theviewpoint
viewpointofofthe
thelender
lender

100

100 1 2 3 4
Cash flow diagram on the viewpoint of the borrower
150

Compound Interest

The yield of simple interest is constant throughout the investment term. But when such yield is added to the
principal at regular intervals, and the sum become the new principal then the interest is said to be compounded or
converted.

F = P (1 + I)n or P = F (1 + I)-n

Where;

P = original principal

F = Compound amount or accumulated value of P at the end of n period

j = nominal rate of interest (annual rate)

m = frequency of conversion

i = interest rate per period = j/m

t = term of investment in years

n = total number of conversion periods in the investment term = tm

If compounded annually then i = j and n = t.

Problem:

Using the compound amount formula, find the accumulated value of ₱2000.00 in 5 years if it is invested at
11% compounded quarterly?

Given: Find:

P = ₱2000 i = j/m = 0.11/4 = 0.0275 F

j = 0.11 t = 5 years

m=4 n = tm = 5(4) = 20 periods

 F = P (1 + i)n = (2000)(1 + 0.0275)20 = 2000(1.720484) = ₱2440.86

1 2 3 n
P
Compound interest in the viewpoint of the borrower
F
Interest period

Interest Period Principal at the beginning Interest earned during Amount at the end of Period
of
1 P Pi P + Pi
2 P (1 + i) P (1 + i)i P (1 + i) + P (1 + i)i = P (1 + i)2
3 P (1 + i)2 P (1 + i)2i P (1 + i)2 + P (1 + i)2i = P (1 + i)3
…
n P (1 + i)n-1 P (1 + i)n-1i P (1 + i)n

F = P (1 + I)n F = P (F/P, i%, n)

F given P at i percent in n interest periods

P = F (1 + I)-n P = F (P/F, i%, n)

P given F at i percent in n interest periods

Problem:

Calculate the accumulated amounts after 5 years of ₱1,000 invested at the rate of 10% per year
compounded a) annually, b) semi-annually, c) quarterly, d) monthly, e) daily, f) continuously.

Solution: F = P (1 + i)n

a. F = 1000 (1 + 0.10)5 = 1610.51

b. F = 1000 (1 + 0.10/2)10 = 1628.89
c. F = 1000 (1 + 0.10/4)20 = 1638.62
d. F = 1000 (1 + 0.10/12)60 =1645.31
e. F = 1000 (1 + 0.10/365)1825 = 1648.61
f. F = Pern
P = Fern F = Pern = 1000e(0.10)(5) = 1648.72 where e = 2.718

Problem:

A man bought a lot worth ₱1,000,000 if paid in cash. On the installment basis, he paid a down payment of
₱200,000; ₱300,000 at the end of one year; ₱400,000 at the end of three years and a final payment at the end of
five years. What was the final payment if interest was 20%.
 Solution:

800,000

1 2 3 4 5
0
300,000
Q
400,000
400,000 (P/F, 20%,3)

Q (P/F, 20%,5)

Using today as the focus date, the equation of value is

800,000 = 300,000 (P/F, 20%, 1) + 400,000 (P/F, 20%, 3) + Q (P/F, 20%, 5)

= 300,000 (1.20)-1 + 400,000 (1.20)-3 + Q (1.20)-5

800,000 = 300,000 (0.8333) + 400,000 (0.5787) + Q (0.4019)

Q = 792,560.00

Another Solution: 800,000

Using 5 years from today as the focus date, the equation of the value is 800,000 (F/P, 20%, 5)
Q + 400,000 ( F/P , 20%,2 ) + 300,000 ( F/P, 20%, 4) = 800,000 ( F/P, 1 2 3 4 5
0
20%, 5)
Q
Q + 400,000 (1 + 0.20)2 + 300,000 (1 + 0.20)4 = 800,000 (1 + 0.20)5 300,000 400,000

Q + 400,000 (1.44) + 300,000 (1.44) = 800,000 (2.4883) 400,000 ( F/P, 20%, 2)

Q = 792,560.00
400,000 ( F/P, 20%, 4)

Discount

Discount on a negotiable paper is the difference between the percent worth (the amount received for the
paper in cash) and the worth of the paper at some time in the future (the face value of the paper or principal).
Discount is the interest deducted in advance.

Discount = Future Worth – Present Worth

 ( 1 + i )-1

1
0

₱1.00

Rate of discount is the discount of one unit of principal for one unit of time.

FW PW

d = 1 – ( 1 + i )-1 1/ ( 1 - d ) = 1 + i

1 – d = 1/( 1 + i ) 1–(1–d)/1–d=i

1 = (1 – d )( 1 + i ) d/ 1 – d = i

1/( 1 – d ) = 1 + I i = d/1 – d

Problem:

A man borrowed 5000 from a bank and agreed to pay the loan at the end of 9 months. The bank discounted
the loan and gave him 4000 in cash.

a. What was the rate of discount?

b. What was the rate of interest?

c. What was the rate of interest for one year?