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Engineering Economy
Annuities, Capitalized Cost, and Amortization

Annuities, Capitalized Cost, and Amortization

This module deals with the different types of annuities, capitalized cost,
and amortization.

At the end of this module, the learner should be able to:

1. Find the annuity given the present value or the future value.
2. Calculate present value, and future values of annuities.
3. Compute the capitalized cost.
4. Determine the amortization.

Definition of Terms
1. Annuity – a series of equal payments occurring at equal periods of time.
2. Ordinary Annuity – payments are made at the end of each period.
(1+𝑖)𝑛 −1
3. [ ] =Uniform series compound amount factor
𝑖
𝑖
4. [(1+𝑖)𝑛−1] =Sinking fund factor

5. Capital Recovery Factor = sinking fund factor + i

6. Deferred Annuity – is one where the first payment is made several
periods after the beginning of the annuity.
7. Capitalized Cost – the sum of the first cost and the present worth of all
costs of replacement equation and maintenance for a long time
8. Amortization – Any method of repaying a debt. It is the principal and
interest included usually by a series of equal payments at equal interval
of time.

Formulas:

Ordinary Annuity
Finding P when A is given
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Engineering Economy
Annuities, Capitalized Cost, and Amortization

𝟏−(𝟏+𝒊)−𝒏
𝑷 = 𝑨[ ]
𝒊
𝑃
𝑃 = 𝐴( , 𝑖%, 𝑛)
𝐴
Finding F when A is given
(𝟏 + 𝒊)𝒏 − 𝟏
𝑭 = 𝑨[ ]
𝒊
𝐹
𝐹 = 𝐴( , 𝑖%, 𝑛)
𝐴
Finding A when P is given
𝒊
𝑨 = 𝑷[ ]
𝟏 − (𝟏 + 𝒊)−𝒏
Finding A when F is given
𝑖
𝐴 = 𝐹[(1+𝑖)𝑛−1] ;
𝐹
A= 𝐹(𝐴 , 𝑖%, 𝑛)

Deferred Annuity
Finding P when A is given
𝟏 − (𝟏 + 𝒊)−𝒏
𝑷 = 𝑨[ ](𝟏 + 𝒊)−𝒎
𝒊
𝑝 𝑃
𝑃 = 𝐴( , 𝑖%, 𝑛)( , 𝑖%, 𝑚)
𝐴 𝐹

Annuity Due

𝟏 − (𝟏 + 𝒊)−𝒏+𝟏
𝑷 = 𝑨 + 𝑨[𝟏 + ]
𝒊
𝑝
𝑃 = 𝐴 + 𝐴( , 𝑖%, 𝑛 − 1)
𝐴

Perpetuity
1−(1+𝑖)−𝑛
𝑃 = 𝐴[ ]
𝑖
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Engineering Economy
Annuities, Capitalized Cost, and Amortization

1−(1+𝑖)−∞
𝑃 = 𝐴[ ]
𝑖
𝑨
𝑷=
𝒊

Capitalized Cost
Case 1: Maintenance Only
𝑨
𝑪𝑪 = 𝑭𝑪 +
𝒊
Case 2: Replacement Only
𝑺
𝑪𝑪 = 𝑭𝑪 + (𝟏+𝒊)𝑲−𝟏

Case 3: Maintenance and Replacement

𝑨 𝑺
𝑪𝑪 = 𝑭𝑪 + +
𝒊 (𝟏 + 𝒊)𝒌 − 𝟏
Where:
𝐶𝐶 = 𝐶𝑎𝑝𝑖𝑡𝑎𝑙𝑖𝑧𝑒𝑑 𝑐𝑜𝑠𝑡
𝐹𝐶 = 𝐹𝑖𝑟𝑠𝑡 𝑐𝑜𝑠𝑡
𝑆 = 𝑎𝑚𝑜𝑢𝑛𝑡 𝑡𝑜 𝑟𝑒𝑝𝑙𝑎𝑐𝑒 𝑎 𝑝𝑟𝑜𝑝𝑒𝑟𝑡𝑦 𝑒𝑣𝑒𝑟𝑦 𝑘 𝑝𝑒𝑟𝑖𝑜𝑑
𝑘 = 𝑝𝑒𝑟𝑖𝑜𝑑

Solved Problems on Annuities

1. A chemical engineer wishes to set up a special fund by making uniform

semi-annual end-of-period deposits for 20 years. The fund is to provide
P100, 000 at the end of each of the last five years of the 20-year period.
If interest is 8% compounded semi-annually, what is the required semi-
annual deposit to be made?

Solution:

8%
𝐹𝑜𝑟 𝑡ℎ𝑒 𝑑𝑒𝑝𝑜𝑠𝑖𝑡𝑠, 𝑖 = = 4%
2
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Engineering Economy
Annuities, Capitalized Cost, and Amortization

𝐹𝑜𝑟 𝑡ℎ𝑒 𝑤𝑖𝑡ℎ𝑑𝑟𝑎𝑤𝑎𝑙𝑠, 𝑖 = (1 + 0.04)2 − 1 = 0.0816 𝑜𝑟 8.16%

Using 20 years from today as the focal date, the equation of value is

𝐴(𝐹/𝐴, 4%, 40) = 𝑃100, 000 (𝐹/𝐴, 8.16%, 5)

𝐴(95.0255) = 𝑃100, 000(5.8853)

𝑨 = 𝑷𝟔, 𝟏𝟗𝟑. 𝟑𝟗

2. If money is worth 8% compounded quarterly, compare the present

values of the following:
a) An annuity of P1000 payable quarterly for 50 years;
b) An annuity of P1000 payable quarterly for 100 years;
c) A perpetuity of P1000 payable quarterly.
Solution:
1−(1+0.02)−200
a) 𝑃 = 𝑃1, 000 [ ] = 𝑷𝟒𝟗, 𝟎𝟒𝟕. 𝟑𝟓
0.02
1−(1+0.02)−400
b) 𝑃 = 𝑃1, 000 [ ] = 𝑷𝟒𝟗, 𝟗𝟖𝟏. 𝟖𝟓
0.02
1000
c) 𝑃 = [ 0.02 ] = 𝑷𝟓𝟎, 𝟎𝟎𝟎

3. A steam boiler is purchased on the basis of guaranteed performance.

However, initial tests indicate that the operating cost will be P40, 000
more per year than guaranteed. If the expected life is 25 years and
money is worth 10%, what deduction from the purchased price would
compensate the buyer for the operating cost?
Solution:
1−(1+𝑖)−𝑛
𝑃 = 𝐴[ ]
𝑖

1 − (1 + 0.1)−25
𝑃 = 𝑃40, 000[ ]
0.1
𝑷 = 𝑷𝟑𝟔𝟑, 𝟎𝟖𝟏. 𝟔𝟎
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Engineering Economy
Annuities, Capitalized Cost, and Amortization

4. The buyer of a certain machine may pay either 200,000 cash down
payment and 200, 000 annually for the next 6 years, or pay 350, 000
cash and 200, 000 annually for the next five years. If the money is
worth 12% compounded annually, which method of payment is better
for the buyer and by how much?
Solution:

𝐿𝑒𝑡 𝑃1 𝑏𝑒 𝑡ℎ𝑒 𝑝𝑟𝑒𝑠𝑒𝑛𝑡 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑡ℎ𝑒 𝑓𝑖𝑟𝑠𝑡 𝑚𝑒𝑡ℎ𝑜𝑑

𝑃2 𝑏𝑒 𝑡ℎ𝑒 𝑝𝑟𝑒𝑠𝑒𝑛𝑡 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑡ℎ𝑒 𝑠𝑒𝑐𝑜𝑛𝑑 𝑚𝑒𝑡ℎ𝑜𝑑
1 − (1 + 0.12)−6
𝑃1 = 𝑃200, 000 [ ] + 𝑃200, 000
0.12

𝑃1 = 𝑃1, 022, 281.43

1 − (1 + 0.12)−5
𝑃2 = 𝑃200, 000 [ ] + 𝑃350, 000
0.12
𝑃2 = 𝑃1, 070, 955.24
𝑃1 − 𝑃12 = 𝑃1, 022, 281.4 − 𝑃1, 070, 955.24 = P48, 673.82
𝑻𝒉𝒆𝒓𝒆𝒇𝒐𝒓𝒆 𝒕𝒉𝒆 𝒇𝒊𝒓𝒔𝒕 𝒑𝒂𝒚𝒎𝒆𝒏𝒕 𝒊𝒔 𝒃𝒆𝒕𝒕𝒆𝒓 𝒃𝒚 𝐏𝟒𝟖, 𝟔𝟕𝟑. 𝟖𝟐 𝐀𝐧𝐬.

5. A company set aside 500, 000 at the end of each year for company
expansion. If the fund earns 10% compounded annually, how long will
it take before 10 million can be saved?
Solution:
(1 + 𝑖)𝑛 − 1
𝐹 = 𝐴[ ]
𝑖

(1 + 0.10)𝑛 − 1
10, 000, 000 = 500, 000 [[ ]]
0.10
10000000
ln [( 0.1) + 1] = 𝑛[ln(1 + 0.1)]
500000
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Engineering Economy
Annuities, Capitalized Cost, and Amortization

10000000
ln [( 0.1) + 1]
𝑛= 500000
ln(1 + 0.1)
𝒏 = 𝟏𝟏. 𝟓𝟐 𝒚𝒆𝒂𝒓𝒔
6. If P10, 000 is deposited each year for 9 years, how much annuity can a
person get annually from the bank every year for 8 years starting 1
year the 9th deposit is made. Cost of money is 14%.

Solution:

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

A(P/A, 14%, 8) (P/F, 14%, 9) = P10, 000 (P/A, 14%, 9)

1 − (1 + 0.14)−8 1 − (1 + 0.14)−9
𝐴 (1 + 0.14)−9 = 𝑃10, 000
0.14 0.14
A (4.63886) (0.30751) = P10, 000 (4.94637)

A= P34, 675

Using 9 years from today as a focal date, the equation of value is

A (P/A, 14%, 8) = P10, 000 (F/A, 14%, 9)

A (4.63886) = P10, 000 (16.08535)

A = P34, 675

Using 17 years from today as the focal date, the equation of value is

A (F/A, 14%, 8) = P10, 000 (F/A, 14%, 9) (F/P,

14%, 8)

A (4.63886) = P10, 000 (16.08535)

(2.85259)

A = P34, 675

7. A man invests P100, 000 now for the college education of his 2-year old
son. If the fund earns 14% effective, how much will the son get each
year starting from his 18th to 22nd birthday?
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Engineering Economy
Annuities, Capitalized Cost, and Amortization

Solution:
1 − (1 + 0.14)−5
100000 = 𝐴 [ ] (1 + 0.14)−15
0.14
𝑨 = 𝑷𝟐𝟎𝟕, 𝟗𝟏𝟔. 𝟑𝟗

8. A person buys a piece of property for P100,000 down payment and ten
deferred semi-annual payments of P8000 each starting three years
from now. What is the present value of the investment if the rate of
interest is 12% compounded semi-annually?
Solution:
𝐿𝑒𝑡 𝑃𝑇 𝑏𝑒 𝑡ℎ𝑒 𝑝𝑟𝑒𝑠𝑒𝑛𝑡 𝑤𝑜𝑟𝑡ℎ 𝑜𝑓 𝑎𝑙𝑙 𝑝𝑎𝑦𝑚𝑒𝑛𝑡𝑠
𝑃5 𝑏𝑒 𝑡ℎ𝑒 𝑝𝑟𝑒𝑠𝑒𝑛𝑡 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑖𝑛𝑠𝑡𝑎𝑙𝑙𝑚𝑒𝑛𝑡 𝑎𝑡 𝑝𝑒𝑟𝑖𝑜𝑑 5
1 − (1 + 0.06)−5
𝑃5 = 80000 [ ] (1 + 0.06)−5 = 43999.08162
0.06
𝑃𝑇 = 100000 + 43999.08162
𝑷𝑻 = 𝑷𝟏𝟒𝟑 𝟗𝟗𝟗. 𝟎𝟖

9. During the first 10 years of the life of a certain machine the following
were spend for its maintenance: During the first 5 years, P3000 was
spent each year, during the second five years, P5000 each year was
spent. In addition, 8, 000 was spent for overhauling at the end of the
fourth year, and P10, 000 also for overhauling at the end of the ninth
year.

Solution:
1−(1+0.09)−5 1−(1+0.09)−5
𝑃 = 3000[ ]+ 5000 [ ] (1 + 0.09)−5 +
0.09 0.09

8000(1 + 0.09)−4
+ 10000(1 + 0.09)−9
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Engineering Economy
Annuities, Capitalized Cost, and Amortization

𝑃 = 𝑃34580.66
0.09
𝐴 = 34580.66[ ]
1 − (1 + 0.09)−10
𝑨 = 𝟓𝟑𝟖𝟖. 𝟑𝟔

10. A man bought an equipment costing P60, 000 payable in 12 quarterly

payments, each instalment payable at the beginning of each period. The
rate of interest 24% compounded quarterly what is the amount of each
payment?

Solution:

24%
P = P60, 000 n = 12 i= = 8%
3

𝑃 = 𝐴 (1 + 𝑃/𝐴, 2%, 𝑛 − 1)

𝑃60, 000 = 𝐴 (1 + 𝑃/𝐴, 8%, 11)

𝑃60, 000 = 𝐴 (1 + 7.1390)

𝑨 = 𝑷𝟕, 𝟑𝟕𝟏. 𝟗𝟏

11. A certain property is being sold and the owner received two bids. The
first bidder offered to pay P400, 000 each year for 5 years, each payment
is to be made at the beginning of each year. The second bidder offered to
pay P240, 000 first year, P360, 000 the second year and P540, 000 each
year for the next three years, all payments will be made at the beginning
of each year. If money is worth 20% compounded annually, which bid
should the owner of the property accept?

Solution:

Let P1 = present worth of the first bid

𝑃1 = 𝐴 (1 + 𝑃/𝐴, 20%, 4)
= 𝑃400, 000 (1 + 𝑃/𝐴, 20%, 4)
= 𝑃400, 000 (1 + 2.5887)
= 𝑷𝟏, 𝟒𝟑𝟓, 𝟒𝟖𝟎
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Engineering Economy
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Second bid:
𝐿𝑒𝑡 𝑃2 = 𝑝𝑟𝑒𝑠𝑒𝑛𝑡 𝑤𝑜𝑟𝑡ℎ 𝑜𝑓 𝑡ℎ𝑒 𝑠𝑒𝑐𝑜𝑛𝑑 𝑏𝑖𝑑
𝑃2 = 𝑃240,000 + 𝑃360,000(𝑃/𝐹, 20%, 1) + 𝑃540,000(𝑃/𝐴, 20%, 3)(𝑃/
𝐹, 20%, 1)
= 𝑃240,000 + 360,000(0.8333) + 𝑃540,000(2.1065)(0.8333)
= 𝑷𝟏, 𝟒𝟖𝟕, 𝟖𝟕𝟓
The owner of property should accept the second bid.

12. What amount of money invested today at 15% interest can provide the
following scholarships: P30,000 at the end of each year for 6 years;
P40,000 for the next 6 years and P50,000 thereafter?

Solution:

𝑃 𝑃 𝑃
𝑃 = 𝑃30,000 ( , 15%, 6) + 𝑃40,000 ( , 15%, 6) ( , 15%, 6)
𝐴 𝐴 𝐹
𝑃50,000
+ 0.15 (𝑃/𝐹, 15%, 12)

𝑃50,000
= 𝑃30,000(3.7845) + 𝑃40,000(3.7845)(0.4323) + (0.1869)
0.15

= 𝑷𝟐𝟒𝟏, 𝟐𝟕𝟕

13. Calculate the capitalized cost of a project that was an initial cost if
P3000000.00 and an additional investment cost of P1000000.00 at the
end of every 10 years. The annual operating cost will be P100000.00 at
the end of every year for the first four years and P160000.00 thereafter.
In addition there is expected to be a recurring major rework cost of
P300000.00 every 13 years. Assume i= 15%.
Solution:
1000000 1 − (1 + 0.15)−4
𝐶𝐶 = 3000000 + + 100000 [ ]
(1 + 0.15)10 0.15
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Engineering Economy
Annuities, Capitalized Cost, and Amortization

160000 300000
+ (1 + 0.15)−4 +
0.15 (1 + 0.15)13
𝑪𝑪 = 𝑷𝟒𝟐𝟖𝟏𝟗𝟗𝟎. 𝟎𝟎 𝐴𝑛𝑠.

14. A debt of P5000 with interest at 12% compounded semi-annually is to

be amortized by equal semiannual payments over the next 3 years, the
first due in six months. Find the semi-annual payment and construct an
amortization schedule.
Solution:
𝑖
𝐴 = 𝑃[ ]
1 − (1 + 𝑖)−𝑛
0.06
𝐴 = 5000 [ ]
1 − (1 + .06)−6
𝑨 = 𝟏𝟎𝟏𝟔. 𝟖𝟐
Amortization Schedule
Outstanding
Principal
Principal at the Interest due at
Period Payment repaid at end
beginning of end of period
of period
period

1 5000.00 300.00 1016.82 716.82

2 4283.18 256.99 1016.82 759.83
3 3523.35 211.40 1016.82 805.42
4 2717.93 163.08 1016.82 853.74
5 1864.19 111.85 1016.82 904.97
6 959.22 57.55 1016.82 959.27
Totals P1100.87 P6,100.92 P5000.05

15. A debt of P10, 000 with interest at the rate of 20% compounded semi-
annually is to be amortized by five equal payment is to be made after 3
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Engineering Economy
Annuities, Capitalized Cost, and Amortization

years. Find the semi-annual payment and construct an amortization

schedule.
Solution:

𝑃 = 𝐴(𝑃/𝐴, 10%, 5)(𝑃/𝐹, 10%, 5)

𝐴𝑚𝑜𝑟𝑡𝑖𝑧𝑎𝑡𝑖𝑜𝑛 = 𝑃(𝐴/𝑃, 10%, 5)(𝐹/𝑃, 10%, 5)
= 𝑃10, 000(0.2638)(1.6105)
𝑨 = 𝑷𝟒, 𝟐𝟒𝟖. 𝟓𝟎

Amortization Schedule
Outstanding
principal at Interest due at Principal repaid
Period Payment
beginning of end of period at end of period
period
1 P10, 000.00 P1, 000.00
2 11, 000.00 1, 100.00
3 12, 100.00 1, 210.00
4 13, 310.00 1, 331.00
5 14, 641.00 1, 464.10
6 16, 105.10 1, 610.51 P4, 248.50 P2, 637.99
7 13, 467.11 1, 346.71 4, 248.50 2, 901.79
8 10, 565.32 1, 056.53 4, 248.50 3, 191.97
9 7, 373.35 737.34 4, 248.50 3, 511.16
10 3, 862.19 386.22 4, 248.50 3, 862.28
TOTALS P11, 242.41 P21, 242.50 P16,
105.19