UNIVERSITY OF SOUTHERN MINDANAO

ENGINEERING ECONOMY
EngSci 19
 Interest and Money-Time
Relationship
• Interest – is the amount of money paid for the use of
borrowed capital or the income produced by money
which has been loaned
• Simple Interest – calculated using the principal only,
ignoring any interest that had been accrued in preceding
periods.
𝐼 = 𝑃𝑛𝑖
𝐹 = 𝑃 + 𝐼 = 𝑃 + 𝑃𝑛𝑖
𝐹 = 𝑃 1 + 𝑛𝑖
Where: I =interest P= principal of present worth
n=number of interest periods F= accumulated amount
i = rate of interest per interest period
EngSci 19 – Engineering Economy 2
 Simple Interest
• Ordinary Simple Interest – computed on the
basis of 30 days per month (360 days per year)

• Exact Simple Interest – based on the exact

number of days in a year (365 or 366 days per
year)

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 Example 1:
Determine the ordinary simple
interest on ₱700 for 8 months and
15 days if the rate of interest is 15%.

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 Example 2:
Determine the exact simple
interest on ₱500 for the period
from January 10 to October 28,
1996 at 16% interest.

EngSci 19 – Engineering Economy 5

 Example 3:

What will be the future

worth of money after 14
months. If a sum of ₱10,000 is
invested today at a simple
interest rate of 12% per year?

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 Example 4:
What is the annual rate of
interest if ₱265 is earned in four
months on an investment of
₱15,000?

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 Example 5:
A loan of ₱2,000 is made for a
period of 13 months, from January 1
to January 31 the following year, at
a simple interest rate of 20%. What
future amount is due at the end of
the loan period?

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 Cash-Flow Diagrams
• A cash-flow diagram is simply graphical
representation of cash flows drawn on a time
scale.
• Receipt - positive cash flow or cash inflow
• Disbursement – negative cash flow or cash
outflow

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 Compound Interest
• Compound Interest – the interest for an interest
period is calculated on the principal plus total
amount of interest accumulated in previous
periods.
• Compound Interest – interest on top of interest.

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 Compound Interest
Principal at
Interest Earned Amount at End of
Interest Period Beginning of
During Period Period
Period
1 P Pi P+Pi=P(1+i)
P(1+i)+P(1+i)i =
2 P(1+i) P(1+i)i
P(1+i)2
P(1+i)2+P(1+i)2i =
3 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

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 Rate of Interest
• Nominal rate of interest – specifies the rate of
interest and a number of interest periods in one
year
𝑟
𝑖=
𝑚

where: i = rate of interest per interest period

r = nominal interest rate
m = number of compounding periods
per year
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 Rate of Interest
• Effective rate of interest – is the actual or exact
rate of interest on the principal during one year.

Effective rate = F1 – 1 = (1+i)m – 1

Where: F1 = the amount ₱1.00 will be after one year

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 Example 1:
Find the nominal rate which if
converted quarterly could be used instead of
12% compounded monthly. What is the
corresponding effective rate?

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 Example 2:
Find the amount at the end of
two years and seven months if
₱1000 is invested at 8%
compounded quarterly using simple
interest for anytime less than a year
interest period.

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 Example 3:
A ₱2000 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 semiannually. How much
should the borrower pay at the end of 7
years?
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 Example 4:
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%?
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 Example 5:
A man wishes his son to receive
₱200,000 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?
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 Continuous Compounding and
Discrete Payments
• Discrete compounding – the interest is
compounded at the end of each finite-length
period, such as a month, a quarter or a year.
• Continuous compounding – it is assumed that
cash payments occur once per year, but the
compounding is continuous throughout the year.

𝐹 = 𝑃𝑒 𝑟𝑛

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 Example 1:
Compare the accumulated amounts
after 5 years of ₱1,000 invested at the
rate of 10% per year compounded (a)
annually, (b) semiannually, (c)
quarterly, (d) monthly, (e) daily, and (f)
continuously.

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 Discount
• Discount – on a negotiable paper is the
difference between the present 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 interest paid in
advance.
• Rate of Discount – is the discount on one
unit of principal for one unit of time.
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 Discount
𝑑 =1− 1+𝑖 −1

𝑑
𝑖=
1−𝑑

Where: d = rate of discount for the period involved

i = rate of interest for the same period

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 Example 1:
A man borrowed ₱5,000 from a bank
and agreed to pay the loan at the end of 9
months. The bank discounted the loan and
gave him ₱4,000 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?

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 Inflation
• Inflation – is the increase in the prices of goods
and services from one year to another, thus
decreasing the purchasing power of money.
𝐹𝐶 = 𝑃𝐶(1 + 𝑓)𝑛

Where: PC = present cost of a commodity

FC = future cost of the same commodity
f = annual inflation rate
n = number of years

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 Inflation
• In an inflationary economy, the buying power of
money decreases as costs increase.

𝑃
𝐹=
(1 + 𝑓)𝑛

Where: F = is the future worth, measured in today’s

peso.
P = present amount

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 Inflation
• If interest is being compounded at the same time
that inflation is occurring.

• The future worth will be:

𝑃(1 + 𝑖)𝑛 1+𝑖 𝑛

𝐹= 𝑛
= 𝑃( )
(1 + 𝑓) 1+𝑓

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 Example 1:
An item presently costs ₱1000. If
inflation is at the rate of 8% per year,
what will be the cost of the item in two
years?

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 Example 2:
An economy is experiencing
inflation at an annual rate of 8%. If this
continues, what will ₱1000 be worth
two years from now, in term’s of
today’s peso?

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 Example 3:
A man invested ₱10,000 at an
interest rate of 10% compounded
annually. What will be the final amount
of his investment, in terms of today’s
pesos, after five years, if inflation
remains the same at the rate of 8% per
year?

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