CE 427 CMPM Lecture 7

Construction Economics
 Economics
• social science that seeks to analyze and
describe the

• production,
• distribution, and
• consumption of wealth.
 Construction Economics
Application of the techniques and expertise of
economics to the study of the
• the construction process and
• the construction industry.

Construction economics deals with study , but not

limited to :

 Time Value of Money (simple and compound Interests

 Depreciation
 Total Owning and Operation Cost for Equipment
 Part 1 : A .Time Value of Money:
Simple and Compound Interests

• Interest is the cost of borrowing money, where the borrower pays a

fee to the lender of the loan.
• Simple interest is an annual payment based on a percentage of the
saved or borrowed amount, also called the annual interest rate.

• Simple interest grows based only on the money you deposit or

invest (called the principal).

• A.1 Simple Interest Formula:

B=P(1 + r t)
 Where B=Balance= Final amount at end of term

Note :
Balance is the total amount in the account at the end of the
term, whose length is a time t in years.

I=Interest= P x r x t
P=Principal= initial/original amount loaned or borrowed
r=rate of interest
t=time in years or Number of time periods elapsed​
(length of the loan)
 Interest = P x r x t

Simple Interest= P r t Amount

1 Year S.I = (1000 × 5 × 1)/100 = 50 A = 1000 + 50 = 1050

2 Year S.I = (1000 × 5 × 2)/100 = 100 A = 1000 + 100 = 1100

3 Year S.I = (1000 × 5 × 3)/100 = 150 A = 1000 + 150 = 1150

 Simple Interest Calculation Example

Vicente Lao Construction Inc. takes out a P1,200,000 loan from

BPI to buy a concrete mixer.

The loan has 4% interest, and a term of 24 months (2 years).

How much interest will the contractor pay on this loan?

Balance=?
Principal=1200 000
rate=0.04
time in years= 24 months =use 2 years
 formula for Simple Interest:

B=P(1+rt)

B=1,200,000(1+.04(2))=1200 000(1.08)= P1 296 000

Interest= B-P = 1 296 000- 1 200 000= P 96,000

(answer)
 Example 2
A construction loan was obtained from BPI amounting to
P2,000,000 to build a new building.
The loan term is 3 years, and the interest rate is 5%.
The interest is calculated using the simple interest
method. How much interest will be payed on this loan?

B=P(1+rt)

B=2 000 000(1+.05(3))= P 2,300,000

Interest paid = P 300,000 Answer
 Example 3
You invested P1,000,000 in a PAGIBIG FUND with a 4%
annual interest rate, paid semi-annually (twice a year),
with a maturity in 4 years.

How much will your money be after 4 years?

Solution

Principal =P1,000,000

r= 4% = 2% = 0.02 since it will be paid semi annualy(twice a year)

2
t= number of time period= 4 years x 2 semi annual payments =8
 continued
B=P(1+rt)

B= 1 000 000(1+ 0.02(8))= P1,160,000

 B. Compound Interest
• Compound interest is interest earned not just based on
the saved or borrowed amount, but also on the interest
already earned so far.

• With compound interest, you earn based on the

principal plus the interest you've already earned.

B(t) = P ( 1+r )nt

n
Sample compound Interest calculations
for 5 Years at 10%:

Loan at
Year Interest Loan at End
Start

0 (Now) $1,000.00 ($1,000.00 × 10% = ) $100.00 $1,100.00

1 $1,100.00 ($1,100.00 × 10% = ) $110.00 $1,210.00

2 $1,210.00 ($1,210.00 × 10% = ) $121.00 $1,331.00

3 $1,331.00 ($1,331.00 × 10% = ) $133.10 $1,464.10

4 $1,464.10 ($1,464.10 × 10% = ) $146.41 $1,610.51

5 $1,610.51
 Where:
• B= Final amount
• P= Initial principal balance
• r= Interest rate
• n= Number of times interest is applied
per time period (see table below)
• t = time in years =
Number of time periods elapsed​
Note : “n” values

Number of times per year

“n” value
Interest is calculated

Annually 1

Monthly 12

Weekly 52

Daily 365
Compound Interest Sample Calculation
Example 1
EEI contractors would like to purchase a dragline
excavator for river de-silting worth P 6,490 ,000.

A Bank loan was approved for 4 % interest rate

compounded monthly. how much will EEI
contractor owe the bank after 2 years?

B(t) = P ( 1+r )nt

n
 We've shown that:
• Balance=?
• Principal= P 6, 490, 000
• n= compounded monthly=12
• rate=.04 (4%)
• time in years=2 years

B(2) =6 490 000 (1+.04)12×2

12
B(2)= P 7,029,598 at end of two years
Interest = P 7,029,598- P 6 490 000= P 539, 598 after two years
(Answer)
 Example 2
• A construction loan was obtained from BPI amounting to

P2,000,000 to build a new home.

• The loan term is 3 years, and the interest rate is 5% compounded

monthly .

• The interest is calculated using the Compound interest method. How

much interest will be payed on this loan?

B(t) = P ( 1+r )nt

n
 We've shown that:
• Balance=?
• Principal=2 000 000
• n= monthly=12
• rate=0.05 (5%)
• time in years=3 years
B(3) =2 ,000, 000 (1+.05)12×3
• 12

• B(3) = P 2,322, 945

• interest payed is P 322, 945 answer

•
•
(note, it is higher compared to simple interest calculation)
 C. Depreciation

• Decline of an Asset’s value over

time
4 Common Types of Depreciation calculation Method

 Straight line method

 Sum of the year’s digits
 Declining balance method
 IRS prescribed method
Car Depreciation Example
 Depreciation

Depreciation correlates the cost of an asset with its usefulness,

or ability to produce revenue, year over year.

Depreciation is an accounting method that spreads the cost of an asset over its
expected useful life
to give a more accurate view of its value and the business’s profitability.
C.1 Straight Line Method
 Example 1

Note
Salvage Value (SV) is the estimated value of a property at the end of
a property's life.

based on what a company expects to receive in exchange for the

asset at the end of its useful life.
 Example 2
• You bought a toyota vios worth P900, 000 in
January 2024.
• Its estimated salvage value after 5 years is
400, 000.
• Solve the depreciation every year
 By straight Line method
Year Depreciation (P) Book value (P)
0 0 900,000
1 100,000 800,000
2 100,000 700,000

3 100,000 600,000

4 100,000 500,000

5 100,000 400,000
(2029) Cost of car after 5 years
 Example 3
• A commercial building has a salvage value of Php
1 million after 50 years.

Annual depreciation is Php 2 M.

Using the Straight Line Method, how many years

after should you sell the building for Php 30 M

• Note ;this 30 M is the salvage value at “n” years)

 Solve for initial cost first
• Annual depreciation = (Cost - Salvage)
n

2,000,000 = (Cost - 1)
50

• Therefore , Initial cost Cost = Php 101,000,000

million
• b. Solve for the total depreciation after n
years to have a salvage value of 30 million

• 2,000,000=101,000,000-30,000,000
N
• n = 35.5 years
C.2 Sum of the Years’ Digits method
Example Problem
Sum of year digit

Note: N year1= 5 years

15,000

12,000
 C.3 Double Declining Method
Formula

Declining balance

Note : Here N=5 or 5 years, using the formula,

 50,000-20,000=30,000

30,000-12,000=18,000

18000-7200=10,800

10,800-4320=6480

6480-2592=3888
NOTE 6480-2592=P3888 less than P5000 (salvage value) is not allowed!
Therefore , Use 6480 – P5000= P1480
Note :Use smaller value of D5 (1480 USD)
C.4 IRS prescribed Method (MACRS)
Example

IRS method
 Problems simple interest
1.A friend asks to borrow P 3000 and agrees to
repay it in 2 years with 3% interest per annum.
How much interest will you earn?

2.What is the profit of P650,000 in 6 years at the

rate of profit 7% per annum?
 Problem 2 compound interest
1.Find the compound principal and compound
profit of P15000 in 3 years at a profit 6 percent
per annum.

2. A sum of P100,000 is invested for 3 years at

2% per year. Find the final value.

• Use simple interest

• Use compound interest
 Depreciation problems
• Problem 1
• The equipment bought at a price of Php
450,000 has an economic life of 5 years and
a salvage value of Php 50, 000.

• The cost of money is 12% per year.

• Compute the fourth year depreciation using

Straight Line Method.
• Depreciation = Php 160,200
 Problem 2
The first cost of a machine is Php 1,800,000
with a salvage value of Php 400,000 at the
end of its life of five (5) years.

Det. The book value after 3 years using Sum

of the Year digits method
.
Total depreciation = Php 1,069,962.79
 Problem 3
An equipment costs Php 1,800,000.
At the end of its economic life of five years, its
salvage value is Php 400,000.

A. Using Double Declining Method of Depreciation,

what will be its book value for the third year?

B. Re-solve problem 3 using IRS method

 Lecture 7B

Construction Economics
Part 2
COST OF OWNING AND OPERATION OF EQUIPMENT
Example 1 COST OF OWNING AND OPERATION
OF EQUIPMENT

• ASSUME 2000 HOURS Equipment OPERATION

Twin Engine Scraper Heavy Equipment
 Solution :
Solving the
TOTAL COST= Owning cost + Operation Cost
( Part A ) (Part B)
Depreciation+ Fuel cost
COST RATE + service Cost
(Investment rate +
Tax + + repair Cost
insurance +
+ Tire Cost
storage fee)
+ Wage of operator
 Part A
Solve the :

Owning Cost= Depreciation + Cost Rate

 A. Calculate depreciation in Year 2

Initial Cost-Salvage cost-tire cost

D2= 4 x (Initial cost- Salvage cost- tire cost)

15

Note :
Year digit on second year = 4
Sum of the year for 5 year life = 1+2+3+4+5=15
A.Solve depreciation per hour
 B. Calculate the Cost Rate
Cost rate = cost rate (%) x (Ave. Investment)
hour Hours operated

Cost Rate = Investment rate + Tax + insurance + storage fee

B. Solve cost rate per hour
 B. Calculating cost rate per hour

• Cost rate = cost rate (%) x Ave. Investment

hour Hours operated
Calculating Total Owning Cost per hour
 GIVEN DATA:

• ASSUME 2000 HOURS Equipment OPERATION

 Solution Part B Calculate Operating Cost

Operating Cost= Fuel cost

+ service Cost
+ repair Cost
+ Tire Cost
+ Wage of operator
 b. Solving service cost (average usage scraper)

• Service cost= service cost factor x Fuel cost

d. Repair cost per hour (average, scraper)
c. Calculate repair cost per hour
d. Tire cost per hour ( for scraper twin)
From table 17-4 Expected Average tire life
of twin engine scraper = 3000 hours
E. Operator Wages (given data in problem)
 Calculating Total Operation Cost=
= Fuel cost + service Cost+ repair Cost+ Tire Cost
+ Wage of operator
Calculate Total Owning and Operation Cost
of Scraper Equipment is …
• end