ENGINEERING ECONOMICS

MONEY-TIME RELATIONSHIP

SIMPLE AND COMPOUND INTEREST

 INTEREST

Is the amount of money paid for the use of borrowed

capital or the income produced by money which has
been loaned.
 A. SIMPLE INTEREST

Calculated using the principal only, igonoring any interest

that had been accrued in preceding periods.

I = Pni
F = P+I
I= interest
P= Principal/Present Worth
N= number of interest periods
i=rate of interest per interest period
F= Accumulated amount of future worth
1. If a man borrowed money from his boyfriend with simple interest rate of 12%,
determine the present worth of P75,000 which is due at the end of seven months.

SOLUTION:
F = P (1 + ni)
75,000 = P [1 + (7/12)(0.12)]
P = 70,093.46
 a. ORDINARY SIMPLE INTEREST

Is computed on the basis of 12 months of 30 days

each or 360 days a year.

1 interest period = 360 days

1. Determine the ordinary simple interest on P700 for 8 months and 15 days if the rate
of interest is 15%.

SOLUTION:
Number of days: (8)(30)+15=255 days
I = Pni = P700 * 255/360 * 0.15
I = P74.38
 b. EXACT SIMPLE INTEREST

Is based on the exact number of days n a year, 365

days for an ordinary year and 366 for a leap year

1 interest period = 365 or 366 days

2. Betty has invested P1000, part at 5% and the remainder at 10% simple interest. How
much is invested at a higher rate if the total annual interest from this investment is P95?

SOLUTION:
P5 = principal of 5% simple interest
P10 = principal of 10% simple interest
P5 + P10 = 1000 → equation 1

I5 + I10 = 95
I = Pni
P5(1)(.05) + P10(1)(.10) = 95 → equation 2

Solving the 2 equations:

P5 = P100
P10 = P900
3. Determine the accumulated amount using exact simple interest on P1000 for the
period from January 20, 1990 to November 28 of the same year at 15% interest rate.

SOLUTION:
January 20-31 = 11 (excluding January 20)
February = 28
March = 31
April = 30
May = 31 F = P (1 + ni)
June = 30 F = 1,000 [1 + (312/365)(0.15)]
July = 31
F = P1,128.22
August = 31
September = 30
October = 31
November = 28
312 days
Problem 1
Find the interest on P6800.00 for 3 years at 11% simple interest.
A. P1,875.00 C. P2,144.00
B. P1,987.00 D. P2,244.00

Problem 2
A man borrowed P10,000.00 from his friend and agrees to pay at the end of 90 days under 8%
simple interest rate. What is the required amount?
A. P10,200.00 C. P9,500.00
B. P11,500.00 D. P10,700.00

Problem 3 Annie buys a television set from a merchant who offers P 25,000.00 at the end of 60
days. Annie wishes to pay immediately and the merchant offers to compute the required
amount on the assumption that money is worth 14% simple interest. What is the required
amount?
A. P20,234.87 C. P24,429.97
B. P19,222.67 D. P28,456.23
Problem 4
What is the principal amount if the amount of interest at the end of 2½ year is P4500 for a
simple interest of 6% per annum?
A. P35,000.00 C. P40,000.00
B. P30,000.00 D. P45,000.00

Problem 5
How long must a P40,000.00 not bearing 4% simple interest run to amount to P41,350.00?
A. 340 days C. 304 days
B. 403 days D. 430 days

Problem 6
If P16,000 earns P480 in 9 months, what is the annual rate of interest?
A. 1% C. 3%
B. 2% D. 4%
Problem 7. Determine the exact simple interest on 1,000,000 invested for the period
from October 24,1987 to January 7, 1990; if the rate of interest is 17%.
 COMPOUND INTEREST

The interest earned by the principal is

considered as added to the principal, and
therefore will also earn interest for the
succeeding periods.
COMPOUND INTEREST
Example: Noli Castro wants to know how large his
deposit of PhP 10,000 today will become at a
compound annual interest rate of 10% for 5 years.

n 5
F= P( 1 + i ) F = PhP 10,000 x (1+0.10)
F = PhP 16, 105.10
Example: Let us assume that Noli Castro needs PhP 50,000 in
3 years. Let’s examine the process to determine how much he
needs to deposit today at a discount rate of 8% compounded
annually?

-n -3
P=F(1+i) P = PhP 50,000 x (1+0.08)
P = PhP 39,691.61
 Example: How long would it take for PhP 500
invested today at 15% interest per year to be worth
PhP 1,000?
RATES OF INTEREST
 NOMINAL RATE OF INTEREST

-is the basic annual rate of interest.

-specifies the rate of interest and a number of
interest periods in one year.
 NOMINAL RATE OF INTEREST

i= r/m

i= rate of interest per interest period

r= nominal interest rate
m=number of compounding periods per year
If the nominal rate of interest is 10% compounded quarterly find the rate of interest per
interest period.

SOLUTION:

i = r/m
i = 10/4
i = 2.5%
EFFECTIVE RATE OF INTEREST
 EFFECTIVE RATE OF INTEREST

Is the actual or exact rate of interest on the

principal during one year.
𝑟 𝑚
ER= (1 + ) −1
𝑚
ER= er – 1 – continuous compounding
where m is the number of interest period per year
r is the nominal rate of interest (per year)
1. If the nominal rate of interest is 10% compounded quarterly find the actual rate of
interest after one year.

SOLUTION:
ER = (1 + r/m)m – 1
ER = (1 + 0.10/4)4 – 1
ER = 0.1038 or 10.38%
2. Find the nominal rate which if converted quarterly could be used instead of 12%
compounded monthly. What is the corresponding effective rate?

SOLUTION:
r% compounded quarterly = 12% compounded monthly

Note: For two or more nominal rates to be equivalent, the corresponding effective rates
must be equal.
ERQ = ERM
(1 + r/4)4 – 1 = (1 + 0.12/12)12 – 1
r = 0.1212 or 12.12% compounded quarterly

ER = (1 + 0.12/12)12 – 1
ER = 0.1268 or 12.68%
 18% Compounded Monthly

What It Really Means?

•Interest rate per month (i) = 18%/12 = 1.5%
•Number of interest periods per year (n) = 12

In words,
•Bank will charge 1.5% interest each month on your
unpaid balance, if you borrowed money.
•You will earn 1.5% interest each month on your
remaining balance, if you deposited money.
18% Compounded Monthly
1. If you are investing your money which is better: 12%
compounded monthly or 12.5% compounded
annually?
2. Calculate the effective rate per annum (year)
corresponding to each of the following rates:
a)9% compounded semi annually
b)9% compounded bi-monthly
c) 9% compounded quarterly
d)9% compounded monthly
e)9% compounded continuously
 CASH FLOW DIAGRAM

-a graphical representation of cash flows drawn

on a time scale.

Receipt (positive cash flow or cash inflow)

Disbursement (negative cash flow or cash outflow)
 CASH FLOW DIAGRAM
A loan of P100 at simple interest of 10% will become
P150.00 after 5 years.

Cash flow diagram

from the viewpoint of
the lender.
 CASH FLOW DIAGRAM
A loan of P100 at simple interest of 10% will become
P150.00 after 5 years.

Cash flow diagram

from the viewpoint of
the borrower.
DISCRETE/CONTINUOUS COMPOUNDING
DISCRETE/CONTINUOUS COMPOUNDING
1. Compare the accumulated amounts after 5 years of P1,000 invested at the rate of
10% per year compounded (a) annually, (b) semiannually, (c) quarterly, (d) monthly, (e)
daily, and (f) continuously.

SOLUTIONS: Use the formula, 𝑭 = 𝑷 𝟏 + 𝒊 𝒏

a. 𝑭 = 𝑷 𝟏, 𝟎𝟎𝟎 𝟏 + 𝟎. 𝟏𝟎 𝟓
𝟏𝟎 𝟐(𝟓)
b. 𝑭 = 𝑷 𝟏, 𝟎𝟎𝟎 𝟏 + 𝟎. 𝟐
𝟏𝟎 𝟒(𝟓)
c. 𝑭 = 𝑷 𝟏, 𝟎𝟎𝟎 𝟏 + 𝟎. 𝟒
𝟏𝟎 𝟏𝟐(𝟓)
d. 𝑭 = 𝑷 𝟏, 𝟎𝟎𝟎 𝟏 + 𝟎. 𝟏𝟐
𝟏𝟎 𝟑𝟔𝟓(𝟓)
e. 𝑭 = 𝑷 𝟏, 𝟎𝟎𝟎 𝟏 + 𝟎. 𝟑𝟔𝟓
f. 𝑭 = 𝑷𝒆𝒓𝒏 = 𝑷𝟏, 𝟎𝟎𝟎 𝒆 .𝟏𝟎𝒙𝟓
2. James deposited a sum of P12,000 in an account earning interest rate of 9%
compounded quarterly.
a. What will it become after 1 year?
b. What is the effective rate?
c. What is then the equivalent nominal interest rate if compounded monthly?

SOLUTION:
a. F = P (1 + i)n
F = 12,000 (1 + 0.09/4)4(1)
F = P13,117
c. ERM = ERQ
b. ER = interest earned in one (1 + r/12)12 – 1 = 0.0931
year/principal at the beginning of the year r = 0.0893 or 8.93%
ER = (13,117 – 12,000)/12,000
ER = 0.0931 or 9.31%
or
ER = (1 + 0.09/4)4 – 1
ER = 0.0931 or 9.31%
3. Based on the cash flow diagram, compute the amount saved in the bank at the end of
5 years if interest is 12% compounded yearly.

SOLUTION:
F = P (1 + i)n

Deposits:
F10k = 10,000(1 + 0.12)4 = 15,735.19
F13k = 13,000(1 + 0.12)2 = 16,307.20
F15k = 15,000(1 + 0.12)1 = 16,800.00
Total Deposits: 48,842.39

Withdrawals:
F5k = 5,000(1 + 0.12)3 = 7,024.64
20,000.00
Total Withdrawals: 27,024.64

Savings = Total Deposits – Total Withdrawals

= 48,842.39 - 27,024.64
Savings = P21,817.75
4. A P2000 loan was originally made at 8% simple interest for 4 years. At the end of this
period the loan was extended for 3 years, without the interest being paid, but the new
interest rate was made 10% compounded semi-annually. How much should the borrower
pay at the end of 7 years?

SOLUTION:
F4 = P(1+ni) = P 2,000[ (1+(4)(0.08)]
= P 2,640.00
F7 = F4 (1+i)^n = 2,640 (1+0.05)^6)
= P 3, 537.86
CONTINUOUS COMPOUNDING
How many years are required for P1000 to increase to P2000 if invested at 9% per year
compounded continuously?

SOLUTION:
F = Pert
2,000 = 1,000e0.09t
t = 7.70 years
PROBLEM OF THE DAY: (1/4 sheet of paper)

1. A man wishes his son to receive P200,000 ten years from now.
What amount should he invest if it will earn interest of 10%
compounded annually during the first 5 years and 12%
compounded quarterly during the next 5 years?
“God doesn’t call the qualified.
He qualifies whom he calls.”