Engineering Economy

Lesson 9 Problems:
1. Choose from the two machines which is more
economical:
MACHINE A MACHINE B
First Cost Php 8,000 Php 14,000
Salvage Value Php 0 Php 2,000
Annual Operation Php 3,000 Php 2,400
Annual Php 1,200 Php 1,000
Maintenance
Taxes and 3% 3%
Insurance
Life and Years 10 years 15 years

Money is worth at least 16%.

Solutions:

By Rate of Return on Additional Investment Method:

Machine A

Annual Costs:

Php8,000 8,000
Depreciation= = =Php375.20865
F / A , 16 % , 10 21.32147

n 10
F ( 1+i ) −1 ( 1+0.16 ) −1 3.411435079
Where = = =21.32147
A i 0.16 0.16

Depreciation Php 375.20865

Operation Php 3,000
Maintenance Php 1,200
Salvage Value Php 0
Taxes and Insurance (8,000) Php 60
(0.03)
Total Annual Cost Php 4,635.21

Machine B

Annual Costs:

Php14,000 14,000
Depreciation= = =Php 271.00528
F / A , 16 % , 15 51.65951

n 15
F ( 1+i ) −1 ( 1+0.16 ) −1 8.265520865
Where = = =51.65951
A i 0.16 0.16

Depreciation Php271.00528
Operation Php 2,400
Maintenance Php 1,000
Salvage Value Php 2,000
Taxes and Insurance (14,000) Php 420
(0.03)
Total Annual Cost Php 6,091

Annual savings=Php6,091−4,635.21=Php 1455.79

Additional Investment=14,000−8,000=Php 6,000

1455.79
Rate of Returnon Additional Investment = x 100=24.26> 16 %
6000

Therefore, Machine B should be selected.

By Annual Cost Method:

Machine A
Annual Costs

Depreciation Php 375.20865

Operation Php 3,000
Maintenance Php 1,200
Salvage Value Php 0
Taxes and Insurance (8,000) Php 60
(0.03)
Interest on Capital (8,000) Php 1280
(0.16)
Total Annual Cost Php 5,915.21

Machine B
Annual Costs
Depreciation Php271.00528
Operation Php 2,400
Maintenance Php 1,000
Salvage Value Php 2,000
Taxes and Insurance (14,000) Php 420
(0.03)
Interest on Capital (14,000) Php 2240
(0.16)
Total Annual Cost Php 8831

Since Annual Cost of Machine B is greater than the Annual Cost of Machine A ;
Machine B should be selected .

By Present Method:
Machine A
Annual Costs (Excluding Depreciation)

Operation Php 3,000

Maintenance Php 1,200
Salvage Value Php 0
Taxes and Insurance (8,000) Php 60
(0.03)
Total Annual Cost Php 4,260

PWC A=Php 8,000+ 4,260( P/ A , 16 % , 10)

 n 10
P ( 1+i ) −1 (1+ 0.16 ) −1 3.411435079
Where n
= 10
= =4.83277
A i (1+i ) 0.16 ( 1+0.16 ) 0. 7058296126

PWC A=8,000+4260 (4.83277)

¿ 8000+20587.6002

¿ Php28,587.6

Machine B
Annual Costs (Excluding Depreciation)

Operation Php 2,400

Maintenance Php 1,000
Salvage Value Php 2,000
Taxes and Insurance (14,000) Php 420
(0.03)
Total Annual Cost Php 5,820

PWC B=Php 14,000+5,820(P/ A , 16 % , 15)

n 15
P ( 1+i ) −1 (1+ 0.16 ) −1 8.265520865
Where = = =5.57644
A i (1+i )n 0.16 ( 1+0.16 )
15
1.482483338

PWC B=14,000+5,820( 5.57644)

¿ 14,000+20587.6002

¿ Php32,454.88

Since PWC ( B ) < PWC ( A ) for the same period of time;

Machine B should be selected .

By the Equivalent Uniform Annual Cost Method:

Machine A

EUAC( A)=Capital Recovery− Annual Cost

 ¿ Php8,000 ( A / P ,16 % , 10)+ 4620

n 10
A i (1+i ) 0.16 ( 1+0.16 ) 0. 7058296126
Where n
= 10
= =0.20690
P ( 1+i ) −1 (1+ 0.16 ) −1 3.411435079

EUAC( A)=8,000(0.20690)+ 4620

¿ Php6275.2

Machine B

EUAC(B)=Capital Recovery−Annual Cost

¿ Php14,000( A / P ,16 % ,15)+5820

n
A i (1+i ) 0.16 ( 1+0.16 )15 1.482483338
Where = = =0.17936
P ( 1+i )n −1 (1+ 0.16 )15−1 8.265520865

EUAC(B)=14,000 (0.17936)+ 5820

¿ Php8331

Since EUAC (B)< EUAC ( A), Machine B ismore economical

2. A company is going to buy a new machine for

manufacturing its product. Four different machines
are available, cost, operating and other expenses are
as follows:

A B C D
First Cost 24,000 30,000 49,600 52,000
Power per year 1,300 1,360 2,400 2,020
Labor per year 11,600 9,320 4,200 2,000
Maintenance per 2,8000 1,900 1,300 700
year
Taxes and Insurance 3% 3% 3% 3%
Life and years 5 5 5 5

Money is worth 17% before taxes to the company.

Which machine should be chosen?

Solving for Machine A:

By Rate of Return on Additional Investment Method:

Assume : MARR ( i ) before taxes=17 %

Using the MARR ( i ) after taxes=17 % ( 1−0.03 ) x 100=16.49 %

First Cost after tax cash flow =24,000(1 – 0.03)=23,280

Annual Costs:

Php23,280 23,280
Depreciation= = =Php 3,352.50
F / A , 16.49 % , 5 6.94408

n 5
F ( 1+i ) −1 ( 1+0.1649 ) −1 1.145078679
Where = = =6.94408
A i 0.1649 0.1649

Depreciation Php 3,352.50

Power Php 1,300
Maintenance Php 2,800
Labor Php 11,600
Taxes and Insurance (23,280) Php 698.4
(0.03)
Total Annual Cost Php 19,751
Solving for Machine B:
By Rate of Return on Additional Investment Method:

Annual Costs:

First Cost after tax cash flow =30,000 (1 – 0.03 )=29,100

Php29,100 29,100
Depreciation= = =Php 4,190.62
F / A , 16.49 % , 5 6.94408

n 5
F ( 1+i ) −1 ( 1+0.1649 ) −1 1.145078679
Where = = =6.94408
A i 0.1649 0.1649

Depreciation Php 4,190.62

Power Php 1,360
Maintenance Php 1,900
Labor Php 9,320
Taxes and Insurance ( 29,100 ) Php 873
(0.03)
Total Annual Cost Php 17,644.62

Solving for Machine C:

By Rate of Return on Additional Investment Method:

Annual Costs:

First Cost after tax cash flow =49,600 ( 1 – 0.03 )=48,112

Php 48,112 48,112

Depreciation= = =Php 6928.50
F / A , 16.49 % , 5 6.94408

n 5
F ( 1+i ) −1 ( 1+0.1649 ) −1 1.145078679
Where = = =6.94408
A i 0.1649 0.1649
Depreciation Php 6928.50
Power Php 2,400
Maintenance Php 1,300
Labor Php 4,200
Taxes and Insurance (48,112) Php 1,443.36
(0.03)
Total Annual Cost Php 16,271.86

Solving for Machine D:

By Rate of Return on Additional Investment Method:

Annual Costs:

First Cost after tax cash flow =52,000 ( 1 – 0.03 )=50,440

Php50,440 50,440
Depreciation= = =Php 7263.74
F / A , 16.49 % , 5 6.94408

n 5
F ( 1+i ) −1 ( 1+0.1649 ) −1 1.145078679
Where = = =6.94408
A i 0.1649 0.1649

Depreciation Php 7263.74

Power Php 2,020
Maintenance Php 700
Labor Php 2,000
Taxes and Insurance (50,440) Php 1,513.2
(0.03)
Total Annual Cost Php 13,496.94

Annual savings=Php19,751−17,644.62−16,271.86−13,496.94=Php 27,682.42

Additional Investment=23,280−29,100−48,112−50,440=Php 104,372

27,682.42
Rate of Returnon Additional Investment = x 100=26.52>16.49 %
104,372
Therefore, with the lowest annual cost of 13,496.94, the
company should choose Machine D.

By Present Method:
Assume : MARR ( i ) before taxes=17 %
Using the MARR ( i ) after taxes=17 % ( 1−0.03 ) x 100=16.49 %

Machine A
Annual Costs (Excluding Depreciation)

Power Php 1,300

Maintenance Php 2,800
Labor Php 11,600
Total Yearly Cash Flow Php 15,700

First Cost after tax cash flow =24,000(1 – 0.03)=23,280

Total Yearly Cash Flow after tax cash flow=15,700 ( 1−0.03 )=15,229

PW =Php 23,280+15229(P/ A , 16.49 %, 5)

n 5
P ( 1+i ) −1 ( 1+ 0.1649 ) −1 1.145078679
Where n
= 5
= =3.23721
A i (1+i ) 0.16 49 (1+ 0.1649 ) 0.3537234742

PW =23,280+15229(3.23721)

¿ 23,280+49,299.47

¿ Php72,579.47

Machine B
Annual Costs (Excluding Depreciation)

Power Php 1,360

Maintenance Php 1,900
Labor Php 9,320
Total Yearly Cash Flow Php 12,580

F irst Cost after tax cash flow=30,000 ( 1 – 0.03 ) =29,100

Total Yearly Cash Flow after tax cash flow=12,580 ( 1−0.03 )=12,202.6

PW =Php 29,100+12,202.6( P/ A , 16.49 %, 5)

n 5
P ( 1+i ) −1 ( 1+ 0.1649 ) −1 1.145078679
Where n
= 5
= =3.23721
A i (1+i ) 0.16 49 (1+ 0.1649 ) 0.3537234742

PWC A=29,100+12,202.6(3.23721)

¿ 29,100+39502.37875

¿ Php68,602.38

Machine C
Annual Costs (Excluding Depreciation)

Power Php 2,400

Maintenance Php 1,300
Labor Php 4,200
Total Yearly Cash Flow Php 7,900

First Cost after tax cash flow =49,600 ( 1 – 0.03 )=48,112

Total Yearly Cash Flow after tax cash flow=7,900 ( 1−0.03 )=7,663

PW =Php 48,112+7,663( P / A ,16.49 % ,5)

n 5
P ( 1+i ) −1 ( 1+ 0.1649 ) −1 1.145078679
Where n
= 5
= =3.23721
A i (1+i ) 0.16 49 (1+ 0.1649 ) 0.3537234742

PW =48,112+7,663(3.23721)

¿ 48,112+ 24,806.74023
 ¿ Php72,918.74

Machine D
Annual Costs (Excluding Depreciation)

Power Php 2,020

Maintenance Php 700
Labor Php 2,000
Total Yearly Cash Flow Php 4,720

First Cost after tax cash flow =52,000 ( 1 – 0.03 )=50,440

Total Yearly Cash Flow after tax cash flow=4,720 ( 1−0.03 ) =4,578.4

PW =Php 50,440+ 4,578.4 (P/ A ,16.49 % ,5)

n
P ( 1+i ) −1 ( 1+ 0.1649 )5−1 1.145078679
Where = = =3.23721
A i (1+i )n 0.16 49 (1+ 0.1649 )
5
0.3537234742

PW =50,440+ 4,578.4(3.23721)

¿ 50,440+14,821.24226

¿ Php65,261.24

Therefore, with the lowest present worth of 65,261.24, the

company should choose Machine D.

3. An oil company is being offered a special coating for the

gasoline underground tank, installation in its service stations
which will increase the life of the tank from the usual 10
years to 15years. The cost of the special costing will increase
the cost of the Php40,000 tank to 58,000. Cost of installation
for either of the tanks is Php 24,000. If salvage value for
both is zero, and interest rate is 26% would you recommend
the use of the special coating?
Given: with Interest Rate = 26%
Machine without Machine with special
coating coating
First Cost Php 40,000 Php 58,000
Installation Php 24,000 Php 24,000
Salvage Php 0 Php 0
Value
Estimated 10 years 15 years
Life

Solution:
Machine without coating:

Php 40,000+ Php 24,000

Depreciation=
F / A ,26 % ,10

n 10
F ( 1+i ) −1 ( 1+0.26 ) −1
Where = = =34.94494688
A i 0.26

Php 40,000+ Php 24,000

Depreciation= =Php 1831.45221
34.94494688

Machine with special coating:

Php 58,000+ Php 24,000

Depreciation=
F / A , 26 % ,15
 n 15
F ( 1+i ) −1 ( 1+0.26 ) −1
Where = = =119.346505
A i 0.26

Php 58,000+ Php 24,000

Depreciation= =Php687.07500
119.346505

Comparing the results of machine without coating and

machine with special coating:

Rate if Return on Additional Investment on machine with special coating :

Annual savings=Php1831.45221−687.07500=Php1,144

Additional Investment=58,000−40,000=Php18,000

1,144
¿ x 100=6.36 %<26 %
18,000
ROR on Additional Investment on machine with special coating is equalt o
6.36 % withtheinterest rate of 26 % .
Therefore , machine with special coating should not be use .

Engineering Economy

Lesson 10 Problems:
1. The XYZ company has two plants producing “K Specials” . It
has the following expected data for the next month’s
operations. Variable (incremental) costs vary linearly from
zero production to maximum capacity production.
PLANT A PLANT B
Max. Capacity, 1,000 800
Units
Total Fixed Cost 750,000 480,000
Variable 900,000 800,000
(incremental) Costs
max. Capacity

a) Performance has not been good, so the company expects

to receive domestic orders for only 1,200 units next month
at a price of P 1,400 per unit. How should the production
be distributed between the plants for optimum economic
operations?

b). If a friendly foreign power offers to buy 350 additional

units at P1,100 per unit, should the company accept this
offer? Show the incremental gain or loss.

Solution:
A. Expected domestic orders to receive = 1,200 units
Plant A:

1000 X =900,000
1000=1000

X =900
 Plant B:
800Y =800,000
800=800

Y =1000
Unit per month Variable Costs Total Variable
Costs
Plant A Plant B Plant A Plant B
400 800 360,000 800,000 1,160,000
500 700 450.000 700,000 1,150,000
600 600 540,000 600,000 1,140,000
700 500 630,000 500,000 1,130,000
800 400 720,000 400,000 1,120,000
900 300 810,000 300,000 1,110,000
1000 200 900,000 200,000 1,100,000

Therefore, Plant A should produce 1,000 units and 200 units for
Plant B

B. Increment Revenue for 350 units:

( 350 ) ( 1,100 )=385,000

Increment Cost:

Plant B ( 350 ) ( 1,000 )=350,000

Therefore, with gain of 35,000, the company should

accept the offer.
 2. An asset was purchased 6 years ago at a cost of Php 70,000.
It was estimated to have a useful life of 10 years with a
salvage value of P300 at the end of the time. It is now of no
future use and can be sold for only P800. Determine the
sunk cost if depreciation has been computed by using
Straight Line Method.
A. Straight Line Method
B. The sum of the year’s digit’s method
Solution:
C0 = 7,000
CL = 300
L=6
n=10
Resale Value = Php 800

A. Straight Line Method

(Co−C ( L))( L)
DL =
n

(7,000−300)(6)
D6 =
10
D6 = 4020
C 6=CO – D 6
¿ 7,000 – 4,020
C 6=2,98 0
Sunk cost =book value – resale value
¿ 2,980 – 800
¿ 2,180.00
 B. The sum of the year’s digits method
Sum of digits = 1+2+3+4+5+6+7+8+9+10 = 55
(10+ 9+8+7+ 6+5 )
D6 = ( 7,000−300 )
55

= 5,481.82

C6 = 7,000 – 5,481.82
= 1,518.18
Sunk Cost = 1,518.18 – 800
= 718.18

3. A machine shop purchased 10 years ago a milling machine

for Php60,000. A straight – line depreciation reserve had
been provided on a 20-year life of the machine. The owner of
the machine shop desires to replace the old milling machine
with a modern unit of many advantages costing Php100,000.
It can sell the old unit for Php20,000. How much new capital
will be required for the purchase?
Solution:
o C0 = Php 60,000
o n= 20 years
o Selling price of the shop = Php 20,000
o Cost of new unit = Php 100,000
o Assume that there will be no scrap value at the end of
20 years, Cn = 0
 o The depreciation of a milling machine with an original
cost Co = Php 60,000 10 years ago, having a machine
life of 20 years will be?

Co−Cn 60,000−0
d= n
=
20
=3,000

After 10 years, the depreciation would be;

D10 = 10d= 10(Php 3,000) = Php 30,000

Total Amount Available: Php 30,000 + Php 20,000

= Php 50,000

Therefore, new capital will be required for the purchase

would be:
New Capital Required: Php100,000−Php50,000

New Capital Required : Php 50,000

4. A machine which was purchased for Php85,000 has an

estimated useful life of 4 years and a scrap value of
Php15,000. Use a straight-line method to find the
depreciation expense per year and construct a depreciation
schedule.
Solution:
 For Year 1:
C0 = 85,000
CL = 15,000
L=4
n=1
Using Straight Line Method
Co−C ( L )
d=
n
85,000−15,000
¿
1
¿ 70,000

( Co−C ( L ) ) n
DL =
L
( 85,000−15,000 ) 1
DL =
4
= 17,500

CL = Co – D L
= 85,000 – 17,500
CL = 68,000

For Year 2:
C0 = 85,000
CL = 15,000
L=4
n=2
 Using Straight Line Method
Co−C ( L )
d=
n
85,000−15,000
¿
2
¿ 35,000

( Co−C ( L ) ) n
DL =
L
( 85,000−15,000 ) 2
DL =
4

= 35,000

CL = Co – D L
= 85,000 – 35,000
CL = 58,000

For Year 3:
C0 = 85,000
CL = 15,000
L=4
n=3

Using Straight Line Method

Co−C ( L )
d=
n
85,000−15,000
¿
3
¿ 23,333
 ( Co−C ( L ) ) n
DL =
L
( 85,000−15,000 ) 3
DL =
4
= 52,500

CL = Co – D L
= 85,000 – 52,500
CL = 32,500

For Year 4:
C0 = 85,000
CL = 15,000
L=4
n=4
Using Straight Line Method
Co−C ( L )
d=
n
85,000−15,000
¿
4
¿ 17,500

( Co−C ( L ) ) n
DL =
L
( 85,000−15,000 ) 4
DL =
4
= 70,000
 CL = Co – D L
= 85,000 – 70,000
CL = 15,000

Depreciation Table:

Year Original Annual Cost Accumula Value at

Cost of ted the end of
Depreciatio
Depreciati life
n
on
1 85,000 70,000 17,500 68,000
2 85,000 35,000 35,000 58,000
3 85,000 23,333 52,500 32,500
4 85,000 17,500 70,000 15,000

5. Find the rate of depreciation of a piano which was bought at

Php175,000 and which will have a scrap value of only
Php35,000 after 20 years.
Solution:
C0 = 175,000
CL = 35,000
n=20
Annual Cost of Depreciation:
( Co−C ( L ) )
Dn =
n
(175,000−35,000 )
Dn =
20
= 7,000
 Rate of Depreciation:
Annual Cost of Depreciation
Rate= x 100
Original Cost

7,000
¿ x 100
175,000

Rate = 4%

6. A factory equipment costing Php 731,000 when it was

bought new has a scrap value of only Php98,500. Find the
estimated life of the equipment if the annual depreciation
charge amounts to Php27,500.
Solution:

C0 = 731,000
CL = 98,500
d = 27,500
L = 2 years
d(L)=Co - CL
27,5000 ( L )=731,500−98,500
27,500

L=23 months= ( 2312 months

months )
=1.9∨2 years

7. An equipment costs Php45,500, has an estimated life of 10

years, and has a scrap value of Php7,750. Use the straight-
line method of depreciation to find
a). annual rate of depreciation
 b). annual amount of depreciation
c). book value at the end of the first year

Solution:
C0 = 45,500
CL = 7,750
n=10

Annual Cost of Depreciation:

( Co−C ( L ) )
Dn =
n
( 45,500−7,500 )
Dn =
10

= 3,775

Rate of Depreciation:
Annual Cost of Depreciation
Rate= x 100
Original Cost

3,775
¿ x 100
45,500

Rate = 8.30%

Book Value at the End of the First Year

Cn = Co – D n
= 45,500 – 3,775
Cn = 41,725