ENGINEERING

ECONOMY
Engr. Jhonel S. Española
BONDS

It is a certificate of indebtedness of a
corporation usually for a period not
less than ten years and guaranteed by
a mortgage on certain assets of the
corporation or its subsidiaries.

2
BONDS

Bonds are issued when there is a

need for more capital such as for
expansion of the plant or the
services rendered by the
corporation.

3
BONDS

The face or par value of a bond is the

amount stated on the bond. When the
face value has been repaid, the bond
is said to have been retired or
redeemed. The bond rate is the
interest quoted on the bond.

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 RETIREMENT OF BONDS

• The corporation may issue another set of bonds equal to

the amount of bonds due for redemption.
• The corporation may set up a sinking fund into which
periodic deposits of equal amount are made. The
accumulated amount in the sinking fund is equal to the
amount needed to retire the bonds at the time they are
due.

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 PERIODIC DEPOSIT TO THE SINKING FUND

𝑖
𝐴=𝐹 𝑛
1+𝑖 −1
where:
𝐴 = periodic deposit to the sinking fund
𝐹 = accumulated amount, par value of the bond, needed to
retire the bond
𝑖 = rate of interest in the sinking fund
𝑛 = number of periods

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 INTEREST ON THE BOND PER PERIOD

𝐼 = 𝐹𝑟
where:
𝑟 = bond rate per period

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 TOTAL PERIODIC EXPENSE

𝑖
𝐴+𝐼 =𝐹 𝑛
+ 𝐹𝑟
1+𝑖 −1

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 BOND VALUE

The present worth of all future amounts that are expected to

be received through ownership of the bond.
𝐶 1+𝑖 𝑛−1
𝑃= 𝑛
+ 𝐹𝑟
1+𝑖 𝑖 1+𝑖 𝑛
where:
𝑃 = value of the bond 𝑛 periods before redemption
𝐶 = redemption price, usually equal to 𝐹

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DEPRECIATION

It is a certificate of indebtedness of a
corporation usually for a period not
less than ten years and guaranteed by
a mortgage on certain assets of the
corporation or its subsidiaries.

10
 DEPRECIATION

• Examples of physical depreciation are, wear and tear,

corrosion, accident, deterioration due to age or elements.
• The rest are functional depreciation, and one good
example is obsolescence. This is caused by technological
advances or developments which make an existing
property obsolete. Even though the property has suffered
no physical change, its economic serviceability is reduced
because it is inferior to improved types of similar assets
that have been made available through advancements in
technology.

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 DEPRECIATION

• Depletion is another kind of depreciation is material loss

due to consumption or exploitation particularly applicable
to natural resources.

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 STRAIGHT-LINE METHOD

This is the simplest and most widely used method compared

to any other method. It is based on uniform annual charge. It
doesn’t take into account the interest or profit earned on
accumulated depreciation fund. It is a standard accounting
method acceptable by the Bureau of Internal Revenue.

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 STRAIGHT-LINE METHOD

𝑑 𝑇𝑛 = 𝑛𝑑
𝐹𝐶 − 𝑆𝑉
𝑑=
𝐿
𝐵𝑉𝑛 = 𝐹𝐶 − 𝑛𝑑
where:
𝑑 = periodic depreciation
𝑑 𝑇𝑛 = total depreciation after nth period
𝐿 = service life
𝐵𝑉𝑛 = book-value after nth period

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 SINKING FUND METHOD

It is based on uniform annual charge. It is assumed that a

sinking fund is created to replace the original cost of
equipment. All amounts in the sinking fund (including
interest) earn interest. The company uses the amount
accumulated in its operations, and therefore assumed to
earn interest. It is generally used for economy-study
purposes.

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 SINKING FUND METHOD

𝑖
𝑑 = 𝐹𝐶 − 𝑆𝑉
1+𝑖 𝐿 −1
1+𝑖 𝑛−1
𝑑 𝑇𝑛 = 𝑑
𝑖
𝐵𝑉𝑛 = 𝐹𝐶 − 𝑑 𝑇𝑛

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 DECLINING BALANCE METHOD

Also known as Matheson formula. The annual depreciation

cost is a constant percentage of the salvage value at the
beginning of the year. The annual depreciation cost differs
every year and decreases in absolute value as time
progresses. The salvage value of the property can never
depreciate to zero.

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 DECLINING BALANCE METHOD

𝑑𝑛 = 𝐹𝐶 1 − 𝑓 𝑛−1 𝑓
𝐵𝑉𝑛 = 𝐹𝐶 1 − 𝑓 𝑛
𝑆𝑉 = 𝐹𝐶 1 − 𝑓 𝐿
1
𝑆𝑉 𝐿
𝑓 =1−
𝐹𝐶

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 DOUBLE DECLINING BALANCE METHOD

This method is similar to the declining balance method

except
2
that the f is replaced by .
𝐿

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 SYD

The annual depreciation cost differs each year and

decreases as time progresses. It provides for a rapid
depreciation during the early years of life of property, hence
faster recovery of capital.

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 SYD

(𝐹𝐶 − 𝑆𝑉)(𝐿 + 1 − 𝑛)
𝑑𝑛 =
𝐿 + 1 𝐿/2
𝐹𝐶 − 𝑆𝑉 2𝐿 + 1 − 𝑛 𝑛
𝑑 𝑇𝑛 =
𝐿+1 𝐿
𝐵𝑉𝑛 = 𝐹𝐶 − 𝑑 𝑇𝑛

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 CALCU TECH: STRAIGHT-LINE

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 CALCU TECH: SYD

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 CALCU TECH: DECLINING BALANCE

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 CALCU TECH: DOUBLE DECLINING
BALANCE

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CAPITAL

Refers to wealth in the form of

money or property that can be
used to produce more wealth.

26
FIXED CAPITAL

The capital needed to supply the

necessary manufacturing and
plant facilities.

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WORKING CAPITAL

The capital necessary for the

operation of the plant.

28
TOTAL CAPITAL
INVESTMENT

The sum of the fixed-capital

investment and the working
capital.

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 ROI

Profit or savings (before income tax) divided by investment

required.
𝑝𝑟𝑜𝑓𝑖𝑡
𝑅𝑂𝐼 = × 100%
𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡

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MARR

Also known as Minimum Attractive

Rate of Return or known as hurdle
rate, the interest rate used in the
valuation of profitability of a project in
Present Worth, Future Worth and
Annual Worth Methods.

31
 ANNUAL COST METHOD

The annual cost of the alternatives including the minimum

return on investment is determined. The alternative with the
least annual cost is chosen. This method, like the rate of
return on investment method, applies only to alternatives
which have a uniform cost data for each year and a single
investment of capital at the beginning of the project life.

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 ANNUAL COST METHOD

Typical Cost Factors:

• Depreciation Cost (usually as sinking fund)
• Annual Operating Cost
• Annual Labor Cost
• Insurance and Taxes
• Other Cost
• Return on Investment or Cost of Money

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 IRR

The Internal Rate of Return or the Discounted Cash Flow is

a rate which relates the positive and negative cash flows of a
project.

The method of approach for discounted cash flow takes into

account the time value of money and is based on the amount
of the investment that is unreturned at the end of each year
during the estimated life of the equipment.

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 IRR

Given the (period, cash flow) pairs (𝑛, 𝐶𝑛 ) where 𝑛 is a

positive integer, the total number of periods 𝑁, and the net
present value 𝑁𝑃𝑉, the internal rate of return is given by 𝑟:
𝑁
𝐶𝑛
𝑁𝑃𝑉 = ෍ 𝑛
=0
1+𝑟
𝑛=0

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 POP

This method determines the number of years within which

the invested capital can be recovered out of the expected
cash flow. It does not consider the possible earnings of the
reinvested capital during the pay-put period. One of its
serious disadvantage is that it does not consider the
economic life of the physical asset.

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 POP

Without interest:
𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑏𝑙𝑒 𝐹𝑖𝑥𝑒𝑑 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡
𝑁=
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐶𝑎𝑠ℎ 𝐹𝑙𝑜𝑤 𝑝𝑒𝑟 𝑌𝑒𝑎𝑟
𝐹𝑖𝑥𝑒𝑑 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 − 𝑆𝑎𝑙𝑣𝑎𝑔𝑒 𝑉𝑎𝑙𝑢𝑒
𝑁=
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐴𝑛𝑛𝑢𝑎𝑙 𝑁𝑒𝑡 𝑃𝑟𝑜𝑓𝑖𝑡 + 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐴𝑛𝑛𝑢𝑎𝑙 𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛

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 POP

With interest:
𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑏𝑙𝑒 𝐹𝑖𝑥𝑒𝑑 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 + 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑜𝑛 𝑇𝑜𝑡𝑎𝑙 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡
𝑁=
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐶𝑎𝑠ℎ 𝐹𝑙𝑜𝑤 𝑝𝑒𝑟 𝑌𝑒𝑎𝑟
𝐷𝐹𝐶𝐼 + 𝑇𝐶𝐼 1 + 𝑖 𝑛 − 1
𝑁=
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐴𝑛𝑛𝑢𝑎𝑙 𝑁𝑒𝑡 𝑃𝑟𝑜𝑓𝑖𝑡 + 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐴𝑛𝑛𝑢𝑎𝑙 𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛 𝑎𝑠 𝑎𝑛𝑛𝑢𝑖𝑡𝑦

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 PRESENT WORTH METHOD

The difference between the present value of the annual cash

flows (CF) and the total initial investment (TCI). If the present
worth of the net cash flow is equal to or greater than zero,
the project is justified economically.
𝑁
𝐶𝐹𝑛
𝑁𝑃𝑊 = ෍ 𝑛
− 𝑇𝐶𝐼
1+𝑖
𝑛=1

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BREAKEVEN
Investment of capital, production of
goods, and the rendering of service are
usually done for obtaining profit. In all
situations, production output can be
varied under certain conditions. Related to
such output are fixed and variable costs.
At a certain level of production, the total
income will just equal the total expenses,
resulting in no profit.

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BREAKEVEN
This level of production where
the total income is equal to the
total expenses is called the
break-even point.

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A company issued 50 bonds of P1,000 face value each,
redeemable at par at the end of 15 years to accumulate the funds
required for redemption. The firm established a sinking fund
consisting of annual deposits, the interest rate of the fund being
4%. What was the principal in the fund at the end of the 12th
year?
A. P35,983
B. P38,378
C. P41,453
D. P37,519

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A unit of welding machine costs P45,000 with an estimated life of
5 years. Its salvage value is P2,500. Find its depreciation rate by
straight-line method.
A. 17.75%
B. 19.88%
C. 18.89%
D. 15.56%

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A machine has an initial cost of P50,000 and a salvage value of
P10,000 after 10 years. Find the book value after 5 years using
straight-line method.
A. P12,500
B. P30,000
C. P16,400
D. P22,300

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The initial cost of a paint sand mill, including its installation is
P800,000. The BIR approved life of this machine is 10 years for
depreciation. The estimated salvage value of the mill is P50,000
and the cost of dismantling is estimated to be P15,000. Using
straight-line depreciation, what is the annual depreciation charge
and what is the book value of the machine at the end of six
years?
A. P74,500, P340,250
B. P76,500, P341,000
C. P76,500, P342,500
D. P77,500, P343,250

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An equipment costs P10,000 with a salvage value of P500 at the
end of 10 years. Calculate the annual depreciation cost by sinking
fund method at 4% interest.
A. P791.26
B. P950.00
C. P971.12
D. P845.32

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A machine costing P720,000 is estimated to have a book value of
P40,545.73 when retired at the end of 10 years. Depreciation cost
is computed using a constant percentage of the declining book
value. What is the annual rate of depreciation in %?
A. 28
B. 25
C. 16
D. 30

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ABC corporation makes it a policy that for any new equipment
purchased, the annual depreciation cost should not exceed 20%
of the first cost at any time with no salvage value. Determine the
length of the service life necessary if the depreciation used is the
SYD method.
A. 9 years
B. 10 years
C. 12 years
D. 19 years

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 A company purchases an asset for P10,000 and plans to keep it
for 20 years. If the salvage value is zero at the end of the 20th
year, what is the depreciation in the third year? Use SYD method.
A. P1,000
B. P857
C. P937
D. P747

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An asset is purchased for P9,000. Its estimated life is 10 years
after which it will be sold for P1,000. Find the book value during
the first year if SYD depreciation is used.
A. P8,000
B. P6,500
C. P7,545
D. P6,000

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A machine costing P45,000 is estimated to have a salvage value
of P4,350 when retired at the end of 6 years. Depreciation cost is
computed using a constant percentage of the declining book
value. What is the annual rate of depreciation in %?
A. 33.25
B. 32.25
C. 35.25
D. 34.25

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An asset is purchased for P500,000. The salvage value in 25
years is P100,000. What is the total depreciation in the first three
years using straight line method?
A. P48,000
B. P32,000
C. P24,000
D. P16,000

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Determine the capitalized cost of an equipment costing P2M with
an annual maintenance of P200,000 if money is worth 20% per
annum.
A. P2.5M
B. P2.75M
C. P3M
D. P3.5M

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A community wishes to purchase an existing utility valued at
P500,000 by selling 5% bonds that will mature in 30 years. The
money to retire the bond will be raised by paying equal annual
amounts into a sinking fund that will earn 4%. What will be the
total annual cost of the bonds until they mature?
A. P44,667.98
B. P37,345.78
C. P34,515.05
D. P33,915.05

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A company must relocate one of its factories in three years.
Equipment for the loading duck is being considered for purchase.
The original cost is P20,000, the salvage value after three years
is P8,000. The company’s ROR on money is 10%. Determine the
capital recovery rate per year.
A. 5987.67
B. 5897.56
C. 5625.38
D. 5578.35

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A fixture that costs P700 will save P0.06 per item produced.
Maintenance will be P40 annually, 3500 units are produced
yearly. What is the POP at 10%?
A. 4.12 yrs
B. 4.65 yrs
C. 5.57 yrs
D. 4.85 yrs

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The annual maintenance cost of a machine shop is P69,994. If
the cost of forging is P56 per unit and its selling price is P135 per
unit, find the number of units to be forged to breakeven.
A. 886
B. 885
C. 688
D. 668

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