ENGINEERING ECONOMY

ENGINEERING ECONOMY

INTEREST
INTEREST - is the amount of money or payment for use of a borrowed money or capi-
tal.

SIMPLE INTEREST
SIMPLE INTEREST - is defined as the interest on a loan or principal that is based only
on the original amount of the loan or principal. This means that the interest charges
grow in a linear function over a period of time. If can be calculated using the formula:

I = Pin Where: P - principal I=F-P Where: P - present

i - interest per period F - future
n - number of interest period I - Interest

TYPE OF SIMPLE INTEREST

1. Ordinary Simple Interest - is based on one banker’s year. 1 banker year = 12
months of 30 days each. Also 1 banker year = 360 days.
d
n = ———
360
2. Exact Simple Interest - is based on the exact number of days in a given year. An
ordinary year has 365 days while a leap year (which occurs once every 4 years) has 366
days.
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1. A man borrowed P 20, 000 from a local bank which has a simple interest of 16% but
the interest is to be deducted from the loan at the time that the money was borrowed
and the loan is payable at end of one year. How much is the actual rate of interest.
A. 12% B. 14% C. 10% D. 19%

2. If you borrowed money from a friend with simple interest of 12%, find the present
worth of P 50, 000, which is due at the end of seven months.
A. P 46, 200 B. P 44, 893 C. P 46, 730 D. P 45, 789

3. Tony buys a television set from a merchant who ask P 1,250 at end of 60 days. Tony
wishes to pay immediately and the merchant offers to compute the cash price on the as-
sumption that money is worth 8% simple interest. What is the cash price?
A. P 1,233.55 B. P 1,244.66 C. P 1,323.66 D. P 1,392.66

COMPOUND INTEREST
COMPOUND INTEREST - is defined as the interest of loan or principal which is based not
only on the original amount of the loan or principal but the amount of the loan
or principal plus the previous accumulated interest. This means that the interest
charges grow exponentially over a period of time.

1. On his 6th birthday a boy is left an inheritance. The inheritance will be paid in a lump
sum of P10, 000 on his 21st birthday. What is the present value of the inheritance as
of the boy’s 6th birthday, if the interest is compounded annually? Assume i = 4%.
A. P 6,500 B. P 8, 600 C. P 5, 500 D. P 7, 500

2. A man expects to receive P 25, 000 in 8 years. How much is that money worth now
considering interest at 8% compounded quarterly?
A. P 13,859.12 B. P 13,958.33 C. P 13,675.23 D. P 13,265.83
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3. If P 500,000 is deposited at a rate of 11.25% compounded monthly, determine the
compounded interest after 7 years and 9 months.
A. P 660,550 B. P 670,650 C. P 680,750 D. P 690,850

4. A company invests P 10,000 today to be repaid in 5 years in one lump sum at 12%
compounded annually. How much profit in present day pesos is realized?
A. P 7,632 B. P 7,236 C. P 7,326 D. P 7,362

5. By the condition of a will, the sum of P 20,000 is left to a girl to be held in trust fund
by her guardian until it amounts P 50,000. When will the girl receive the money if the
funds is invested at 8% compounded quarterly?
A. 7.98 years B. 10.34 years C. 10.45 years D. 11.57 years

NOMINAL AND EFFECTIVE RATE OF INTEREST

Rate of interest is the cost of borrowing money. It also refers to the amount earned by
a unit principal per unit time.

Nominal rate of interest is defined as the basic annual rate of interest while effective
rate of interest is defined as the actual or the exact rate of interest earned on the prin-
cipal during 1 year period.

For examples, 5% compounded quarterly.

The nominal rate is 5%, while the effective rate is always greater than 5% because of
the compounding that occurs four times during a year.

The effective rate of interest may be calculated using the following formula:

1. A man borrowed P 100,000 at the interest rate of 12% per annum, compounded
quarterly. What is the effective rate?
A. 3% B. 13.2% C. 12% D. 12.55%

2. A bank pays one percent interest on savings accounts four times a year. The effective
annual interest rate is:
A. 4.05% B. 1.00% C. 2.04% D. 3.36%

3. what is the corresponding effective rate of 18% compounded semi-quarterly?

A. 19.25% B. 19.48% C. 18.46% D. 18.95%
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DISCOUNT

Discount refers to the difference between the future worth of a negotiable paper and its
present worth. It also refers to the sale of stock or share at reduced price. Discount may
refer to the deduction from the published price of services or goods.

Discount = Future worth - Present worth

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ANNUITY
Annuity is defined as a series of equal payments occurring at equal interval of time.
When an annuity has a fix time span, it is known as annuity certain the following are an-
nuity certain:

1. Ordinary Annuity is a type of annuity where the payments are made the end of each
period beginning on the first period.

2. Annuity Due is a type of annuity where the payments are made the beginning of
each period stating from the first period.

3. Deferred Annuity is the one where the first payment does not begin until some later
date in the cash flow.
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When an annuity does not have fixed time span but continues indefinitely, then it is re-
ferred to as a Perpetuity. The sum of a perpetuity is an infinite value.

1. A man purchased on monthly installment a P 100,000 worth brand. The interest rate
is 21% nominal and payable in 20 years. What is the monthly amortization?
A. P 1,101.08 B. P 1,121.01 C. P 1,152.15 D. P 1,128.12

2. 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 & 20th birthday, how much will be left in the account at the
end of the 21st year?
A. P 1,700 B. P 2,500 C. P 3,400 D. P 4,000

3. A young engineer borrowed P 10,000 at 12% interest and paid P 2,000 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?
A. P 6,919.28 B. P 5,674.00 C. P 6,074.00 D. P 3,296.00

4. Mr. Cruz plans to deposit for the education of his 5 year old son. P 500 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:
A. P 13,000 B. P 14,500 C. P 13,500 D. P 14,000

5. An investment of P 350,000 is made to be followed by payments of P 200,000 each

year for 3 years. What is the annual rate of return on investment for the project?
A. 41.7% B. 32.7% C. 51.1% D. 15%
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7. A man paid 10% down payment of P 200,000 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 P 42,821.87, find the value of the “x”?
A. 11 B. 9 C. 7 D. 5

8. A fund donated by a wealthy person to IIEE to provide annual scholarships to deserv-

ing EE students. The fund will grant P 5,000 for each of the first five years, P 8,000 for
the next 5 years and P 10,00 for each year thereafter. The scholarships will start one
year after the fund is established. If the fund earns 8% interest, what is the amount of
the donation?
A. P 101,605.71 B. P 101,505.21 C. P 100,506.21 D. P 99,601.71
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Capitalized Cost is a cost of a property refers to the sum of its first cost and the cost of
perpetual maintenance, therefore

Capitalized Cost = First Cost + Cost of Perpetual Maintenance

Bonds is a long term note or a financial security issued by businesses or corporation and
guaranteed on certain assets of the corporation or its subsidiaries. Bonds are repayable
on maturity and bear a fixed nominal rate of interest. Bond rate refers to the rate of in-
terest that is quoted in the bond. Bond values is the present worth of the future pay-
ments that will be received.

DEPRECIATION

Depreciation is the reduction or fall in the value of an asset or physical property during
the course of its working life and due to passage of time.

Value is the money worth of an asset or product. It also refers to the present worth of
all future profits that are to be received through ownership of a particular property.

Market Value is the amount a willing buyer will pay to willing seller for a property
where each has equal advantage and neither one of them is under a compulsion to buy
or sell.

Book Value is the worth of the property as reflected in the book records of the com-
pany.

Use Value is the amount of the property which the owner believed to be its worth as an
operating unit.

Fair Value is the worth of the property determined by a disinterested person in order to
establish an amount which is fair to both the buyer and the seller.

Salvage Value is the amount obtained from the sale of the property. This is also known
as resale value. Salvage value implies that the property will still be use for the purpose it
is intended.
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Different Method of computing Depreciation of a property:

 ENGINEERING ECONOMY

1. A unit of a welding machine cost P 45,000 with an estimated life of 5 years. Its sal-
vage value is P 2,500. Find its depreciation rate by straight line method.
A. 17.75% B. 19.88% C. 18.89% D. 15.56%

2. A machine has an initial cost of P 50,000 and a salvage value of P 10,000 after 10
years. Find the book value after 5 years using straight line method.
A. P 12,500 B. P 30,000 C. P 16,400 D. P 22,300

3. An equipment costs P 10,000 with a salvage value of P 500 at the end of 10 years.
Calculate the annual depreciation cost by sinking fund method at 4% interest.
A. P 791.26 B. P 950.00 C. P 971.12 D. P 845.32

4. A machine costing P 45,000 is estimated to have a book value of P 4,350 when retired
at the end of 6 years. Depreciation cost is computed using a constant percentage of the
declining book value. What is the annual rate of depreciation?
A. 33.25% B. 32.25% C. 35.25% D. 34.25%

5. ABC corporation makes it a policy that for any new equipment purchased, the annual
depreciation cost should not exceed 20% of the first cost at any time with no salvage
value. Determine the length of service life necessary if the depreciation used is the SYD
method.
A. 9 years B. 10 years C. 12 years D. 19 years

6. A telephone company purchased a microwave radio equipment for P 6 million, freight

and installment charges amounted to 4% of the purchased price. If the equipment will be
depreciated over a period of 10 years with a salvage value of 8%, determine the depre-
ciation cost during the 5th year using SYD method.
A. P 626,269.10 B. P 622,786.07 C. P 638.272.08 D. P 627.989.90
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7. A 6%, find the capitalized cost of a bridge whose cost is P 250M and life is 20 years, if
the bridge must be partially rebuilt at a cost of P 100M at the end of each 20 years.
A. P 275.3M B. P 265.6M C. P 295.3M D. P 282.1M

BREAL EVEN ANALYSIS

Break-even refers to the situation where the sales generated (income) Is just enough
to cover the fixed and variable cost (expenses). The level of production where the total
income is equal to the total expenses is known as break-even point.

Income = Expenses

Break-even chart is a diagram which shows relationship between volume and fixed costs,
variable costs and income. The following is an example of break-even chart.
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Legal Forms of Business Organizations

The legal forms of business organizations are the following:
1. Sole Proprietorship - considered as the simplest type of business organization where
in the firm is owned and controlled by a single person.

2. Partnership - is a firm owned and controlled by two or more persons who are bind to a
partnership agreement.

3. Corporation - is a firm owned by a group of ordinary shareholders and the capital of

which is divided up to the number of shares. It is also defined as a distinct entity Sepa-
rate from the individuals who owns it and can be engage in any business transaction
which a real person could do. This is sometimes known as joint-stock company or a co-
operative.

1. The annual maintenance cost of a machine shop is P 69,994. If the cost of making a
forging is P 56 per unit and its selling price is P 135 per forged unit, find the number
of units to be forged to break-even.
A. 886 units B. 855 units C. 688 units D. 668 units

2. A manufacturer produces certain items at a labor cost of P 115 each, material cost of P
76 each and variable cost of P 2.32 each. If the item has a unit price of P 600, how many
number of units must be manufactured each month for the manufacturer to break-even if
the monthly overhead is P 428,000.
A. 1053 B. 1138 C. 946 D. 1232

3. JRT industries manufactures automatic voltage regulators at a labor cost of P 85 per

unit and material cost of P 350 per unit. The fixed charges on the business are P 15,000
per month and the variable costs are P 20 per unit. If the automatic voltage regulator are
sold to retailers at P 580 each, how many units must be produced and sold per month to
break-even?
A. 104 B. 200 C. 120 D. 150