Engineering Economics

ENEECO30
Topic: Annuity & Inflation

Prepared by:

Kristopher Ralph M. Lagutin

Mechanical Engineer
Registered Master Plumber (RMP)
Contents

• Annuity
• Ordinary Annuity
• Deferred Annuity
• Perpetuity
• Inflation
 - Equal payments
Annuity - Equal interval of time

Types of Annuity

• Ordinary Annuity
• Annuity Due
• Deferred Annuity
• Perpetuity
Ordinary Annuity
Type of annuity where the 1st payment
happen at the end of the first period.

1 2 3 4 5 6 7

A A A A A
 Ordinary Annuity Required: PA

1 2 3 4 5 6 7

A A A A A

𝑁 = 𝑁𝑜. 𝑜𝑓 𝑝𝑎𝑦𝑚𝑒𝑛𝑡𝑠
PA
A −N
PA = 1 − 1 + 𝑖
𝑖
Note: PA is concentrated one period left of the first payment
 Ordinary Annuity Required: FA

1 2 3 4 5 6 7

A A A A A

𝑁 = 𝑁𝑜. 𝑜𝑓 𝑝𝑎𝑦𝑚𝑒𝑛𝑡𝑠 FA

FA = PA 1 + 𝑖 N A N
FA = 1+𝑖 −1
𝑖
Note: FA is concentrated overlapping the last payment
Annuity Due
Type of annuity where the 1st payment
happen at the beginning of the first period.

1 2 3 4 5 6 7

A A A A A A
Annuity Due Required: PA

1 2 3 4 5 6 7

A A A A A A

PA
A −(N−1)
PA = A + 1 − 1 + 𝑖
𝑖
Deferred Annuity
Type of annuity where the 1st payment will
not happen at the beginning or end of the
first period.

1 2 3 4 5 6 7

A A A A A
 Deferred Annuity Required: PA

1 2 3 4 5 6 7

A A A A A

PA
A −𝑁) −𝑥
PA = 1 − 1 + 𝑖 1+𝑖
𝑖
Perpetuity
A perpetuity occurs when a series of
uniform payments, A, continue indefinitely.

1 2 3 4 5 6 7

A A A A A A A

N=∞
Perpetuity Required: PA

1 2 3 4 5 6 7

A A A A A A A

A −𝑁)
N=∞
PA = 1 − 1 + 𝑖
𝑖
0
A −∞)
A
PA = 1 − 1 + 𝑖 PA =
𝑖 𝑖
Note: N = mn N = No. of payments

Mode of payment
A −𝑁)
PA = 1 − 1 + 𝑖
𝑖

Interest rate will follow the mode of payment

Example: if payment is monthly

interest rate (𝑖) should be monthly as well

Sample 1: What is the present worth of a P 500 annuity starting at the end of
the third year and continuing to the end of the fourth year, if the annual
interest rate is 10%?
a. 1584.93 c. 867.77
b. 717.17 d. 731.17 Required:
P=?
Given: A
A = 500 P2 = 1 − 1 + 𝑖 −N
m=1
𝑖
−N
n=3&4 F = P2 = P0 1 + 𝑖 N P0 = P2 1 + 𝑖
𝑖 = 10% −2
500 0.1
P2 = 1− 1+ = 867.77
Solution:
0.1 1
1
0 1 2 3 4 −2
P0 = 867.77 1 + 0.1

P0 P2 A = 500 P = 717.16
Sample 2: Today, a businessman borrowed money to be paid in 10 equal
payments for 10 quarters. If the interest rate is 10% compounded quarterly
and the quarterly payment is P 2,000, how much did he borrow?
a. P 17,304.78 c. P 17,504.13
b. P 17,404.12 d. P 17,604.34 Required:
A P=?
Given: P= 1− 1+𝑖 −N
A = 2,000 𝑖
−mn
m=4 A 𝑖𝑛
P= 1− 1+
mn = 10 𝑖𝑛 𝑚
𝑖𝑛 = 10% 𝑚
−10
2000 0.1
P= 1− 1+
0.1 4
Solution: 4
1 2 3 4 5 … 10

A = 2000 P = P 17,504.13
P = Amount Borrowed N = 10
Sample 3: What annuity is required over 12 years to equate with a future
amount of P 20,000? Assume I = 6% annually.
a. P 1,290.34 c. P 1,107.34 Required:
b. P 1,185.54 d. P 1,205.74
A=?
Given: A
F = 20,000 F= 1+𝑖 N −1
m=1 𝑖
n = 12 12
A 0.06
𝑖 = 6% 20,000 = 1+ −1
0.06 1
1
Solution:

A = P 1,185.54
0 1 2 3 4 5 … 12

A =? ? ?
N = 1 × 12 = 12
F = 20,000
Sample 4: An Electrical Engineer obtained a loan of P 50,000.00 at the rate of
6% compounded annually in order to repair his mistress’ house. How much
must the Electrical Engineer pay monthly to amortize the loan within a period
of ten years?
a. P 560.90 c. P 550.90 Required:
b. P 505.90 d. P 507.90 A =?
Given:
P = 50,000 𝐴 −𝑚𝑛
m = 12 P= 1− 1+𝑖
n = 10 𝑖
𝑖𝑒 = 6% 𝐴 −12×10
50,000 = 1 − 1 + 0.004868
0.004868
Solution:

𝑖𝑒 = 1 + 𝑖 𝑚 −1 P = P 551.08
12
0.06 = 1 + 𝑖12 −1
𝑖12 = 0.004868
Sample 5: What is the future sum of annuity of P 1,000.00 deposited at the
end of every two months for 5 years if the interest rate is 12% compounded
semi-annually?
a. P 42,134.19 c. P 40,143.41
b. P 40,314.91 d. P 38,413.91 Required:
Given: F =?
A = 1,000 𝐴 𝑁
m=6 F= 1+𝑖 −1
n=5 𝑖
𝑖2 = 12% 6×5
1000 0.11768
F= 1+ −1
Solution:
0.11768 6
6
1 + 𝑖2 2 = 1 + 𝑖6 6

0.12 2 𝑖6 6
1+ = 1+ F = P 40,323
2 6
𝑖6 = 0.11768
Sample 6: A television set is available on an easy installment plan. The down
payment is P 3000 and the installment payment are P 500 each payable at
the end of every three months for three years. If interest is 6% compounded
quarterly, what is the equivalent cash price of the television?
a. P 8,453.75 c. P 5,550.50 Required:
b. P 9,353.75 d. P 7,250.50
P=?
Given: A
A = 500 P = 1 − 1 + 𝑖 −N
D = 3000
𝑖
A
m=4 P = D + 1 − 1 + 𝑖 −N
n=3 𝑖
−4×3
𝑖 = 6% 500 0.06
P = 3000 + 1− 1+
Solution: 0.06 4
4
1 2 3 4 5 … 12
A = 500 P = P 8,453.75
D = 3000 N = 3 × 4 = 12
Sample 7: To pay for a farm, Pedro has to make equal payments of P
135,900.00 at the beginning of each six months for eight years. Find the cash
price for the farm, if money is worth 11% compounded semi-annually.
a. P 1.5M c. P 2.5M
b. P 1.7M d. P 2.0M
Given:
A = 135,900 Required:
m=2 Present
n=8
𝑖2 = 11%

Solution:
A −(N−1)
PA = A + 1− 1+𝑖
𝑖
135,900 0.11 −(8×2−1)
PA = 135,900 + 0.11 1− 1 +
2
2

PA = P 1,500,007.25
Sample 8: A man borrows Php 100,000 at 10% effective annual interest. He
must pay back the loan over 30 years with uniform monthly payments due on
the first day of each month. What does the man pay each month?
a. P 840 c. P 870
Required:
b. P 850 d. P 880
Given: A =?
P = 100,000
m = 12 𝐴 −(𝑁−1)
n = 30 P=𝐴+ 1− 1+𝑖
𝑖𝑒 = 10%
𝑖
A −(12×30−1)
100,000 = A + 1 − 1 + 0.007974
0.007974
Solution:
𝑖𝑒 = 1 + 𝑖 𝑚 −1
0.1 = 1 + 𝑖12 12 − 1 A = P 839.187
𝑖12 = 0.007974
Sample 9: How much money must you deposit today in an account earning
10% compounded annually so that you can withdraw P 25,000 yearly
indefinitely starting at the end of the 10th year?
a. P 106,024.4
b. P 180,024.4
c. P 160,043.4
d. P 176,086.4
P9 = 250,000
Given: 𝐴 25,000
A = 25,000 P9 = P9 =
m=1 𝑖 0.10
n = 10 −N
𝑖 = 10% P = P9 1 + 𝑖
−9
P = 250,000 1 + 0.10
Solution: 𝑖 = 10% N=∞

0 2 … 10 11 … ∞
A = 25,000 P = P 106,024.4
P
P9
Inflation
- Is a condition described by a decline
in the purchasing power of money
brought about by a general increase in
the prices of goods and services.
 Inflation
1990 2010 2020
Inflation
F ′ = P(1 + ′
𝑖) N

′ N ±𝑁
F = P(1 + 𝑖) 1 + 𝑖𝑓

±1
1 + 𝑖′ = 1 + 𝑖 1 + 𝑖𝑓
𝑖 → 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑟𝑎𝑡𝑒 − 𝑆𝑎𝑣𝑖𝑛𝑔𝑠
𝑖𝑓 → 𝑖𝑛𝑓𝑙𝑎𝑡𝑖𝑜𝑛 𝑟𝑎𝑡𝑒 + 𝐸𝑥𝑝𝑒𝑛𝑠𝑒𝑠
′
𝑖 → 𝑎𝑑𝑗𝑢𝑠𝑡𝑒𝑑 𝑖𝑛𝑓𝑙𝑎𝑡𝑖𝑜𝑛 𝑟𝑎𝑡𝑒
Sample 14: What is the future worth of my P 100,000 after 5 years if I invest
today at a rate of 12% compounded annually. Inflation rate is 8% per year.
What is the actual effective rate given to the account?
a. P 109,292 & 3.7% c. P 129,942 & 2.7%
b. P 239,942 & 4.7% d. P 119,942 & 3.7%
Given:
𝑖 = 12% Required:
n=5 𝑖′& F
𝑖𝑓 = 8% ±1
1 + 𝑖′ = 1 + 𝑖 1 + 𝑖𝑓
P = 100,000
1 + 𝑖′ = 1 + 0.12 1 + 0.08 −1
Solution:
𝑖 ′ = 3.7%
′ ′ N
F = P(1 + 𝑖 )
F ′ = 100,000(1 + 0.037)5 F = P 119,942
Sample 15: A company invests Php 100,000 today to be repaid in five years in
one lump sum at 12% compounded annually. If the rate of inflation is 3%
compounded annually, approximately how much profit, in present day pesos,
is realized over the five years?
a. P 32,000 c. P 52,000
b. P 56,300 d. P 76,200
Given: Required:
𝑖 = 12% Profit (Interest)
n=5 ±𝑁
′ N
𝑖𝑓 = 3% F = P(1 + 𝑖) 1 + 𝑖𝑓
P = 100,000
F ′ = 100,000(1 + 0.12)5 1 + 0.03 −5
Solution:
F ′ = P 152,021.14
F=P+I
I ′ = 152,021.14 − 100,000
I′ = F′ − P
I′ = P 52,021.14
ASSIGNMENT 1: (Instruction: Provide your Name & Section. Write your
solution in an A4 paper. Show your COMPLETE solution, consider 3 decimal
number and box your final answer)
1. Engr. Sison borrows P 100,000 at 10% effective annual interest. He must
pay back the loan 30 years with uniform monthly payment due on the first
day of each month. What does Engr. Sison pay each month?
2. Mr. Ayala borrows P 100,00 at 10% effective annual interest. He must pay
back the loan over 30 years with uniform monthly payments due on the
first day of each month. What does Mr. Ayala pay each month?
3. You need P 4,000 per year for four years to go to college. Your father
invested P 5,000 in 7% account for your education when you were born. If
you withdraw P 4,000 at the end of your 17th, 18th, 19th, and 20th birthday,
how much will be left in the account at the end of the 21st year?
4. An amortization of a debt is in a form of a gradient series P 5,000 on the
1st year, P 4,500 on the 2nd year, P 4,000 on the 3rd year and P 3,500 on
the 4th year. Determine the future amount of the amortization if interest is
5%.
5. An amortization of a debt is in a form of a gradient series P 5,000 on the
1st year, P 4,500 on the 2nd year, P 4,000 on the 3rd year and P 3,500 on
the 4th year. What is the equivalent uniform periodic payment if interest is
5%?