BECC0413

ENGINEERING ECONOMY

College of Engineering and Architecture Department of Civil Engineering

 Chapter 2

INTEREST AND MONEY-TIME

RELATIONSHIPS

College of Engineering and Architecture Department of Civil Engineering

 ECONOMIC STUDY METHODS

College of Engineering and Architecture Department of Civil Engineering

 PRESENT WORTH (PW)
METHOD

The PW of an investment
alternative is a measure of
how much money an
individual or firm could
afford to pay for the
investment more than its
cost.

College of Engineering and Architecture Department of Civil Engineering

 FUTURE WORTH (FW)
METHOD

Because a primary objective

of all time value of money
methods is to maximize the
future wealth of the owners
of a firm, the economic
information provided by the
Future Worth method is very
useful in capital investment
decision situations.

College of Engineering and Architecture Department of Civil Engineering

 ANNUITIES

College of Engineering and Architecture Department of Civil Engineering

 ANNUITIES

An ANNUITY is a series of equal payments occurring at equal

periods of time.

Symbols and their meanings

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

College of Engineering and Architecture Department of Civil Engineering

 ANNUITIES

When do annuities occur?

ü This occurs when goods are bought on the installment plan.

ü This occurs when a person saves equal amounts and deposits

these periodically in a bank;

ü When equal amounts are set aside at equal intervals of time to

take care of the depreciation of equipment and to provide for their
replacement at a definite future time.

ü Substitution of a series of equal amounts periodically in lieu of

a lump sum at retirement of an individual.

College of Engineering and Architecture Department of Civil Engineering

 ORDINARY ANNUITY An ORDINARY ANNUITY is one
where the payments are made at
the end of each period.

P
0 1 2 3 n-1 n
periods

A A A A A
-1
A(1+i)
A(1+i)-2
A(1+i)-3

A(1+i)-4

A(1+i)-5

College of Engineering and Architecture Department of Civil Engineering

 ORDINARY ANNUITY

Finding P when A is Given Finding F when A is Given

𝟏+𝒊 𝒏−𝟏 𝟏+𝒊 𝒏−𝟏

𝑷=𝑨 𝑭=𝑨
𝒊 𝟏+𝒊 𝒏 𝒊

P = value or sum of money at present

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

College of Engineering and Architecture Department of Civil Engineering

 EXAMPLE 1

What is the future worth of ₱600 deposited at the end of every

month for 4 years if the interest rate is 12% compounded quarterly?

ANSWER:
F = P36,642.83

College of Engineering and Architecture Department of Civil Engineering

 EXAMPLE 2

Mr. Reyes borrows ₱600,000 at 12% compounded annually,

agreeing to repay the loan in 15 equal annual payments. How much
of the original principal is still unpaid after he has made the 8th
payment

ANSWER:
P402,042.05

College of Engineering and Architecture Department of Civil Engineering

 EXAMPLE 3

A young woman, 22 years old, has just graduated from college. She
accepts a good job and desires to establish her own retirement
fund. At the end of each year thereafter she plans to deposit ₱2,000
in a fund at 15% annual interest. How old will she be when the fund
has an accumulated value of ₱1,000,000?

ANSWER:
53 years old

College of Engineering and Architecture Department of Civil Engineering

 ANNUITY DUE An ANNUITY DUE is an annuity
where the payments are made at
the beginning of each period.

P
0 1 2 3 n-1 n
periods

A A A A A A
-1
A(1+i)
A(1+i)-2
A(1+i)-3

A(1+i)-4

A(1+i)-5

College of Engineering and Architecture Department of Civil Engineering

 ANNUITY DUE

Finding P when A is Given Finding F when A is Given

𝟏+𝒊 𝒏−𝟏 𝒏
𝑷=𝑨 𝟏+ 𝑭=𝑷 𝟏+𝒊
𝒊 𝟏+𝒊 𝒏

P = value or sum of money at present

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

College of Engineering and Architecture Department of Civil Engineering

 EXAMPLE 4

A man bought an equipment costing ₱60,000 payable in 12 quarterly

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

ANSWER:
P6,751.53

College of Engineering and Architecture Department of Civil Engineering

 EXAMPLE 5

A certain manufacturing plant is being sold and was submitted for

bidding. Two bids were submitted by interested buyers. The first bid
offered to pay ₱200,000 each year for 5 years, each payment being
made at the beginning of each year. The second bidder offered to
pay ₱120,000 the first year ₱180,000 the second year, and ₱270,000
each year for the next 3 years, all payments being made at the
beginning of each year. If money is worth 12% compounded annually,
which bid should the owner of the plant accept?

ANSWERS:
P1 = P807,469.87
P2 = P859,727.18

College of Engineering and Architecture Department of Civil Engineering

 DEFERRED ANNUITY A DEFERRED ANNUITY is one
where the first payment is made
several periods after the
beginning of the annuity.

m periods n periods
P
0 1 n-1 n
0 1 m
periods

A A A A

A(P/A, i%, n)(P/F, i%,m) A(P/A, i%, n)

College of Engineering and Architecture Department of Civil Engineering

 EXAMPLE 6

A person buys a piece of property for ₱100,000 down payment and

ten deferred semi-annual payments of ₱8,000 each starting three
years from now. What is the present value of the investment if the
rate of interest is 12% compounded semi-annually?

ANSWER:
P = P143,999.08

College of Engineering and Architecture Department of Civil Engineering

 EXAMPLE 7

A man wishes to provide a fund for his retirement such that from his
60th to 70th birthdays he will be able to withdraw equal sums of
₱18,000 for his yearly expenses. He invests an equal amount for his
41st to 59th birthdays in a fund earning 10% compounded annually.
How much should each of these amounts be?

ANSWER:
A = P2,285.25

College of Engineering and Architecture Department of Civil Engineering

 EXAMPLE 8

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 after the 9th deposit is made. Cost of money is 14%.

ANSWER:
A = P34,675.19

College of Engineering and Architecture Department of Civil Engineering

 EXAMPLE 9

M purchased a small lot in a subdivision, paying ₱200,000 down and

promising to pay ₱15,000 every 3 months for the next 10 years. The
seller figured interest at 12% compounded quarterly.

a. What was the cash price of the lot?

b. If M missed the first 12 payments, what must he pay at the time
the 13th is due to bring himself up to date?
c. After making 8 payments, M wished to discharge his remaining
indebtedness by a single payment at the time when the 9th
regular payment was due, what must he pay in addition to the
regular payment then due?
d. If M missed the first 10 payments, what must he pay when the
11th payment is due to discharge his entire indebtedness?

College of Engineering and Architecture Department of Civil Engineering

 PERPETUITY PERPETUITY is an annuity in
which the payments continue
indefinitely.

P
0 1 2 3 n®¥
periods

A A A A

𝑨
𝑷=
𝒊

College of Engineering and Architecture Department of Civil Engineering

 EXAMPLE 10

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

values of the following:
a. an annuity of ₱1,000 payable quarterly for 50 years:
b. an annuity of ₱1,000 payable quarterly for 100 years:
c. a perpetuity of ₱1,000 payable quarterly.

ANSWERS:
a. P = P49,047.35
b. P = P49,981.85
c. P = P50,000.00

College of Engineering and Architecture Department of Civil Engineering

 EXAMPLE 11

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?

ANSWER:
P = P241,282.32

College of Engineering and Architecture Department of Civil Engineering

 CAPITALIZED COST

CAPITALIZED COST is a natural extension and application of

perpetuity. The capitalized cost of any structure or property
(equipment, machinery, building, etc.) is the sum of its first cost
and the present worth of all costs for replacement, operation,
maintenance for a long time or forever, that is:

𝑪𝒂𝒑𝒊𝒕𝒂𝒍𝒊𝒛𝒆𝒅 𝑪𝒐𝒔𝒕 = 𝑭𝒊𝒓𝒔𝒕 𝑪𝒐𝒔𝒕 + 𝑪𝒐𝒔𝒕 𝑷𝒆𝒓𝒑𝒆𝒕𝒖𝒂𝒍 𝑴𝒂𝒊𝒏𝒕𝒆𝒏𝒂𝒏𝒄𝒆

College of Engineering and Architecture Department of Civil Engineering

 CAPITALIZED COST

A A A S S S

0 1 2 3 0 k 2k 3k
P X

𝑨 𝑺
𝑷= 𝑿=
𝒊 𝟏+𝒊 𝒌−𝟏
P is the amount invested now at i% per period whose interest at the end of
every period forever is A while X is the amount invested now at i% per period
whose interest at the end of every k periods forever is S. If k = 1, then X = P.

College of Engineering and Architecture Department of Civil Engineering

 EXAMPLE 12

The capitalized cost of a piece of equipment was found to be

P142,000. The rate of interest used in the computations was 12%,
with a salvage value of P10,000 at the end of a service life of 8 years.
If the cost of perpetual replacement remains constant, determine the
original cost of the equipment.

ANSWER:
FC = P88,687.41

College of Engineering and Architecture Department of Civil Engineering

 EXAMPLE 13

Determine the capitalized cost of a research laboratory which

requires P5,000,000 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?

ANSWER:
Capitalized Cost = P6,573,645.74

College of Engineering and Architecture Department of Civil Engineering

 PRACTICE PROBLEM 1

A man purchased on monthly installment a P100,000 worth of

land. The interest rate is 12% nominal and payable in 20 years. What
is the monthly amortization?

College of Engineering and Architecture Department of Civil Engineering

 PRACTICE PROBLEM 2

You need P4,000 per year for four years to go to college. Your
father invested P5,000 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?

College of Engineering and Architecture Department of Civil Engineering

 PRACTICE PROBLEM 3

What is the accumulated amount of five-year annuity paying

P6,000 at the end of each year, with interest at 15% compounded
annually?

College of Engineering and Architecture Department of Civil Engineering

 PRACTICE PROBLEM 4

A young engineer borrowed P10,000 at 12% interest and paid

P2,000 per annum for the last 4 years. What does he have to pay at
the end of the fifth year in order to pay off his loan?

College of Engineering and Architecture Department of Civil Engineering

 PRACTICE PROBLEM 5

Mr. Cruz plans to deposit for the education of his 5 years old
son, P500 at the end of each month for 10 years at 12% annual
interest compounded monthly. The amount that will be available in
two years is

College of Engineering and Architecture Department of Civil Engineering

 PRACTICE PROBLEM 6

A man paid 10% down payment of P200,000 for a house and lot
and agreed to pay the balance on monthly installments for “x” years
at an interest rate of 15% compounded monthly. If the monthly
installment was P42,821.87, find the value of x.

College of Engineering and Architecture Department of Civil Engineering

 ANSWER KEY

1. P1,101.09
2. P1,699.86
3. P40,454.29
4. P6,917.72
5. P13,486.73
6. 5 years

College of Engineering and Architecture Department of Civil Engineering