ENGINEERING

ECONOMY
BY: HIPOLITO STA. MARIA &
JESUS N. MATIAS
PRINCIPLES OF
INTEREST AND
MONEY-TIME
RELATIONSHIPS
CHAPTER 3
Interest
- Is the amount of money paid for the use
of borrowed capital or the income
produced by money which has been
loaned.
 the amount of money to be paid for the
use of money, which is proportional to the
length of time the principal is used.
Types of interest

 Simple Interest
 Compound Interest
 Continuous Compounding
Simple Interest
- the amount of money to be paid for the use of
money, which is proportional to the length of time the
principal is used.

𝑰 =𝐏 𝐫 𝐭
Where:

I = Interest
P = principal
r = rate of interest
t = time in years

Exact interest for “t” days

 365 for ordinary days

 366 for leap year
Rate of interest – the amount earned by one unit
of principal during a unit time

Ordinary interest for “t” days

 360 for ordinary days
 1 month = 30 days

 Future worth after “t” days

F =P + I
F =P + (P r t)
F =P (1+ r t)
Simple Interest

Type of Simple Interest

 Ordinary simple interest
- Is computed on the basis of 12 months of 30 days each or
360 days a year
 Exact simple interest
- Is based on the exact number of days n a year, 365 days for
an ordinary year and 366 days for a leap year.
Example 1

Determine the ordinary simple interest on P700 for 8 months

and 15 days if the rate of interest is 15%?
Ans. P774.375
Example 2

Determine the exact simple interest on P500 for the period

from Jan 10 to October 28, 2012 at 16% interest per day.
Ans P63.83
Example 3

What will be the future worth of money after 14 months, if the

sum of P10,000 is invested today at a simple interest of 12%
per year.
Ans. P11,400
 Activity #1
1. A price tag of P1200 is payable in 60 days but if paid
with in 30 days it will have a 2% discount. Find the
rate of interest.
2. A man borrowed from a bank under a promissory note
that he signed in the amount of P 25,000.00 for a
period of one year. He received only the amount of
P21, 915.00 after the bank collected the advanced
interest and an additional amount P85.00 for notarial
and inspection fees. What was the rate of interest that
the bank collected in advance?
Cash Flow Diagram
- A cash-flow diagram is simply 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)
 Compound Interest
- In calculations of compound interest, the interest for
an interest period is calculated on the principal plus
total amount of interest accumulated in previous
periods. Thus compound interest means “interest on
top of interest.”

𝑛𝑚
𝐹 = 𝑃 ( 1+𝑖 )
Compound Interest

Where:
F = Future worth
P = Present worth
i = interest rate per interest period
n = number of years
m = number of compounding periods per year
Compound Interest
  For single payment:

Compound amount factor - (F/P, i%, n) F = P(1+i)n

Present worth factor - (P/F, i%, n) F = P(1+i)-n

𝑛
𝐹 = 𝑃 ( 1+𝑖 )
Where:
F = Future worth
P = Present worth
i = interest rate per interest period
n = number of periods
(1+i)n = is called the single payment compound amount factor
  For single payment:

Compound amount factor - (F/P, i%, n) F = P(1+i)n

Present worth factor - (P/F, i%, n) F = P(1+i)-n

Present worth

P=
1
 Is called single payment present
( 1+𝑖 ) 𝑛 worth factor
 For 6% compounded semi-annually for 5 years
0.06
𝑖= = 0.03 & n = 5x(2) = 10
2
For 6% compounded quarterly for 5 years
0.06
𝑖= = 0.015 n = 5x(4) = 20
4
For 6% compounded monthly for 5 years
0.06
𝑖= = 0.005 n = 5x(12) = 60
12
For 6% compounded bi-monthly for 5 years
0.06
𝑖= = 0.01 n = 5x(6) = 30
6
Example 1
The amount of P50,000 was deposited in the bank earning an
interest of 7.5% per annum. Determine the total amount at the
end of 5 years, if the principal and interest were not drawn
during the period.
Example 2

Find the present worth of a future payment of P300,000 to be

made in 5 years with an interest rate of 8% per annum.
Example 3
Find the present worth of a future payment of P100,000 to be
made in 10 years with an interest of 12% compounded
quarterly.
Example 4
In how many years is required for P2,000 to increase to P5,000
if interest at 12% compounded semi-annually?
Example 5
P1,500 was deposited in a bank account, 20 years ago. Today it
is worth P3,000. Interest is paid semi-annually. Determine the
interest rate paid on this account.
Rate of Interest
Nominal rate of interest
- Specifies the rate of interest and a number of interest
periods in one year.

i = rate of interest per interest period

r = nominal rate of interest
m = number of compounding periods per year
Rate of Interest
Effective rate of interest
- The actual or exact rate of interest on the principal during
one year. If P1.00 is invested at a nominal rate of 15%
compounded quarterly, after one year this will become…
Example 1

John borrowed P50,000 from the bank at 25% compounded

semi-annually. What is the effective rate of interest?
Example 2

Compute the equivalent rate of 6% compounded semi-annually

to a rate compounded quarterly.
Example 3

A bank is advertising 9.5% accounts that yields 9.84%

annually. How often is the interest compounded?
Ans. quarterly
Continuous Compounding
In continuous compounding, it is assumed that cash payments
occur one per year, but the compounding is continuous
throughout the year.
Example 1
A nominal interest of 3% compounded continuously is given on
the account. What is the accumulated amount of P10,000 after
10 years?
Example 2
Compute the nominal rate of interest of a continuously
compounded loan if the ERI is 25%?
Example 3
A man wishes to have P40,000 in a certain fund at the end of 8
years. How much should he invest in a fund that will pay 6%
compounded continuously?
Annuities
Is a series of equal payments occurring at equal periods of time.
Types:
 Ordinary
 Deferred
 Annuity due
 Perpetuity
Symbols and their meaning

P= value or sum of money at present

F= value or sum of money at some future time
A= series of periodic, equal amounts of money
n= number of interest periods
i= interest rate per interest period
Ordinary Annuity

Is one where the payments are made at the end of each period
Example 1

What is the present worth and the accumulated amount of a 10-

year annuity paying P10,000 at the end of each year, with
interest at 15% compounded annually?
Ans. P50,158.69 & P203,307.18
Example 2

What is the present worth of P500 deposited at the end of every

three months for 6 years if the interest rate is 12% compounded
semi-annually?
Ans. P8,507.77
Example 3

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 be made?
Ans. P6,193.44
Example 4
A man purchased a house for P425,000. In the first month that he owned the
house, he spent P75,000 on repairs and remodelling. Immediately after the
house was remodelled, he was offered P545,000 to sell the house. After some
consideration, he decided to keep the house and have it rented for P4,500 per
month starting two months after the purchase. He collected rent for 15 months
and then sold the house for P600,000. If the interest rate was 1.5% per month,
how much extra money did he make or lose by not selling the house
immediately after it was remodelled?
Ans. Loss by not selling immediately by P5015
Deffered Annuity

Is one where the first payment is made several periods after the
beginning of the annuity.
Example 1

If P10,000 is deposited each year for 9 years, how much

annuity can a person get annually from the bank every year 8
years starting 1 year after the 9th deposit is made. Cost of
money is 14%.
Ans. P34,675.19
Example 2
On the day his grandson was born, a man deposited to a trust company
a sufficient amount of money so that the boy could receive five annual
payments of P80,000 each for his college tuition fees, starting with his
18th birthday. Interest at the rate of 12% per annum was to be paid on
all amounts on deposit. There was also a provision that the grandson
could elect to withdraw no annual payments and receive a single lump
amount on his 25th birthday. The grandson choose to withdraw on his
25th birthday.
A. How much did the boy receive as a single payment?
B. How much did the grandfather deposited?
Ans. P714,023.45 & P42,001.22
Example 3

A debt of P40,000 whose interest rate is 15% compounded

semi-annually, is to be discharged by a series of 10 semi-annual
payments, the first payment to be made 6 months after
consummation of the loan. The first 6 payments will be P6,000
each, while the remaining 4 payments will be equal and such
amount that the final payment will liquidate the debt. What is
the amount of the last 4 payments?
Ans. P5,454.21
Annuity Due

An annuity due is one where the payments are made at the

beginning of each period.
Example 1

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

quarterly payments, each instalments payable at the beginning
of each period. The rate of interest is 24% compounded
quarterly. What is the amount of each payment?
Ans. P7,371.95
Example 2
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
P200,000 first year, P300,000 the second year and P550,000 each year for
next years, all payments will be made beginning of each year.
If money is worth 20% annually, which bid should the owner of the property
accept.
Ans. First bidder has a lead of P20,003.15
SEATWORK
 IN 5 YEARS, P1.8 M WIIL BE NEEDED TO PAY FOR THE BUILDING
RENOVATION. IN ORDER TO GENERATE THIS SUM, A SINKING
FUND CONSISTING OF THREE ANNUAL PAYMENTS IS
ESTABLISHED NOW. FOR TAX PURPOSES, NO FURTHER
PAYMENTS WILL BE MADE AFTER 3 YEARS. WHAT PAYMENTS
ARE NECESSARY IF MONEY IS WORTH 15% PER ANNUM?
SEATWORK
 FIND THE VALUE AFTER 20 YEARS IN PESOS OF AN ANNUITY OF
P20,000 PAYABLE ANNUALY FOR 8 YEARS WITH FIRST PAYMENT
AT THE END OF 2 YEARS IF MONEY IS WORTH 5%?
 FIND THE PRESENT VALUE OF AN ANNUITY OF P25,000 PAYABLE
ANNUALY FOR 8 YEARS WITH THE FIRST PAYMENT AT THE END
OF 10 YEARS IF MONEY IS WORTH 5%?
SEATWORK
 FIND THE VALUE AFTER 20 YEARS IN PESOS OF AN ANNUITY OF
P20,000 PAYABLE ANNUALY FOR 8 YEARS WITH FIRST PAYMENT
AT THE END OF 2 YEARS IF MONEY IS WORTH 5%?
 FIND THE PRESENT VALUE OF AN ANNUITY OF P25,000 PAYABLE
ANNUALY FOR 8 YEARS WITH THE FIRST PAYMENT AT THE END
OF 10 YEARS IF MONEY IS WORTH 5%?
Perpetuity

A perpetuity is an annuity in which the payments continue

indefinitely.
Example 1

What present sum would be needed for annual end of year

payments of 15,000 each, forever if money is worth 8%.
Ans. P187,500
Example 2

P45,000 is deposited in a savings account that pays 5% interest

compounded semi-annually. Equal annual withdrawals are to be
made from the account, beginning one year from now and
continuing forever. Compute the maximum amount of the equal
annual withdrawal.
Ans. P2,278.13
Example 3

Find the present value of a perpetuity of P100 payable semi-

annually if money is worth 4% compounded quarterly.
Ans. P4,975.12
Seatwork

If money is worth 4%, find the present value of a perpetuity of

P100 payable at the beginning of each year.
Ans. P2,600
Seatwork

If money is worth 8%, obtain the present value of a perpetuity

of P1,000 payable annually when the first payment due at the
end of 5 years.
Ans. P9,187.87
Seatwork

What amount of money invested today at 15% interest can

provide the following scholarship; P30,000 at the end of each
year for 6 years; P40,000 for the next 6 years and P50,000
thereafter?
Ans. P241,277
Capitalized Cost

One of the most important applications of perpetuity is in

capitalized cost. The capitalized cost of any property is the sum
of the first cost and the present worth of all cost of replacement,
operation and maintenance for a long time forever.
CC = FC + Present worth of perpetual operation and/or
maintenance
Maintenance for k years
Example 1

Determine the capitalized cost of a structure that requires an

initial investment of P1,500,000 and an annual maintenance of
P150,000. Interest is 15%.
Ans. P2,500,000
Example 2

A suspension bridge was constructed for P24M. The annual

maintenance cost is P500,000. If the rate of interest of 6%,
compute the capitalized cost of the bridge including
maintenance.
Ans. P32.35M
Example 3

A new engine was installed by a textile plant at a cost of

P300,000 and projected to have a useful life of 15 years. At the
end of its useful life, it is estimated to have a salvage value of
P30,000. Determine its capitalized cost if interest is 18%
compounded annually.
Ans. P324,604
Example 4

A machine cost P150,000 and will have a scrap value of

P10,000 when retired at the end of 15 years. If money is worth
4%, find the annual investment of the machine.
Ans. P12,991.75
Example 5

Determine the capitalized cost of a research laboratory which

requires P5M for original construction; P100,000 at the end of
every year for the first 6 years and then P120,000 each year
thereafter for operating expenses, and P500,000 every 5 years
for replacement of equipment with interest at 12% per annum?
Ans. P6,573,650
Example 6

A bridge that was constructed at a cost of P75,000 is expected

to last 30 years, at the end of which time of its renewal cost
will be P40,000. Annual repairs and maintenance are P3,000.
What is the annual investment for this project. Money is worth
6%.
Ans. P8005.98