BES 02 - Engineering

Economics

This is a property of
PRESIDENT RAMON MAGSAYSAY STATE UNIVERSITY
NOT FOR SALE
BES 02 – Engineering Economics
First Edition, 2021

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Learning Module Development Team

Assigned
Title Author
Chapter
Chapter 1: The Economic Environment
Chapter 2: Interest and Money-Time Relationship Dionisio M. Martin Jr.
Chapter 3: Depreciation
Chapter 4: Capital Financing
Chapter 5: Selections in Present Economy

Evaluators:

(First Name, Middle Initial, Last Name), Position

(First Name, Middle Initial, Last Name), Position
(First Name, Middle Initial, Last Name), Position
Course Overview
Introduction

Engineering Economics is a three-unit basic engineering science course, that is common to all
engineering disciplines. This course discusses the economics environment that affects the
money value in the daily operations in engineering fields.

This course explores the effects of inflation and deflation of money on the market where
engineering plays a part of this important factors in economics. It also involves the systematic
evaluation of the economic benefits of proposed solutions to engineering problems. The
engineering economics involves technical analyzing with emphasis on the economic aspects
and has the objective of assisting decisions.

Course General Objectives

At the end of the semester, 85% of the students have attained 90% level of understanding for
being aware in the engineering economics, locally and globally.

1. Understand the economics environment in engineering field perspective.

2. Solve problems involving interest and the time value of money.
3. Evaluate project alternatives by applying engineering economic principles and
methods and select the most economically efficient one.
4. Deal with risk and uncertainty in project outcomes by applying the basic economic
decision-making concept.
5. Perform mathematically solution to perform decision-making in a certain economic
condition.

Course Details:

 Course Code: BES 02

 Course Title: Engineering Economics
 No. of Units: 3-unit lecture
 Classification: Lecture-based
 Pre-requisite / Co-Requisite: 2nd Year Standing
 Semester and Academic Year: 1st Semester, AY 2021-2022
 Schedule: BSCpE 2A – Monday, Wednesday and Friday, 9:30AM-10:30 AM
 Name of Faculty: Dionisio M. Martin Jr.
 Contact Details
Email: [email protected]
Mobile Number: 0939-906-0585
FB Account: Dionisio Martin Jr.
 Consultation
Day: TTH
Time: 8:00-9:30AM
Learning Management System

The University LMS will be used for asynchronous learning and assessment. The link and class
code for LMS will be provided at the start of class through the class’ official Facebook Group.

 Edmodo
 Google Classroom
 University LMS

Assessment with Rubrics

Students will be assessed in a regular basis thru quizzes, assignments, individual/group outputs
using synchronous and/or asynchronous modalities or submission of SLM exercises. Rubrics
are also provided for evaluation of individual/group outputs.

Major examinations will be given as scheduled. The scope and coverage of the examination
will be based on the lessons/topics as plotted in the course syllabus.
 0323

Module Overview
Introduction

This module aims to introduce economics to engineering students particularly the computer
engineering students as to their chosen field of specialization in engineering. It will let them to
meaning and usage of interest in engineering field. The money time value relationship for
certain applied condition and the depreciation effect to the organization where he/she belongs.
The capital financing suited to start new business or project related in some cases and situation
where the best selection is needed.

On the later part of this module, the application of different methods for different economic
study for engineering will be discussed. The comparing of solved alternatives and the
replacement studies in dealing engineering project study. The break-even analysis as well as
the benefit/cost analysis in establishing new concept and ideas in engineering application
related in computer field.

The students will learn how to make decision using a mathematical approach from solving
different case studies at the end of each lesson/chapter.

Table of Contents

Chapter 1: The Economic Environment

Chapter 2: Interest and Money-Time Relationship
Chapter 3: Depreciation
Chapter 4: Capital Financing
Chapter 5: Preparing for an Engineering Career
Engineering Economics

Chapter 4

Capital Financing
Chapter 4

Capital Financing
Introduction

Businesses run on money. Capital financing refers to the methods you use to raise money to
launch your business and set up cash reserves in case the revenue stream dries up for a while.
The two primary forms of capital finance are selling ownership in your company and taking on
debt.

Capital financing consists of the methods your business can take to raise money. If you're
starting small or you have deep pockets, you may be able to survive with only your own
resources. However, most small businesses rely on raising capital either by debt or equity
financing.

Specific Objectives

At the end of the lesson, the students should be able to:

- understand the concept of capital financing in engineering

- differentiate the types of organizations in a business organization
- determine the capitalization of a corporation
- determine the difference between the bond retirement and bond value
- solve problems related to capital financing

Duration

Chapter 4: Capital Financing = 2 hours

(1.5-hours discussion;
0.5-hour assessment)

_____________________________________________

FINANCING

Types of Organizations
a. Individual Ownership – or sole proprietorship is the simplest form of business
organization, wherein a person uses his or her own capital to establish a business and is
the sole owner.
Advantages:
1. Easy to organize
2. The owner has full control of the enterprise
3. The owner is entitled to whatever benefits and profits that accrue from the
business
4. Easy to dissolve
 Disadvantages:
1. The amount of equity capital which can be accumulated is limited
2. The organization eases upon the death of the owner
3. Difficult to obtain borrowed capital, owing to the uncertainty of the life of
the organization
4. The liability of the owner for his debts is unlimited
b. Partnership – is an association of two or more persons for the purpose of engaging in a
business for profit.
Advantages:
1. More capital may be obtained by the partners pooling their resources together
2. Bound by few legal requirements as to its accounts, procedures, tax forms
and other items of operation
3. Dissolution of the partnership may take place at any time by more agreement
of the partners
4. Provide an any method whereby two or more persons of differing talents may
enter into business, each carrying those burdens that he can best handle
Disadvantages:
1. The amount of capital that can be accumulated is definitely limited
2. The life of the partnership is determined by the life of the individual partners.
When any partner dies, the partnership automatically ends
3. There may be serious disagreement among the individual partners
4. Each partner is liable for the debts of the partnership
c. Corporation – is a distinct legal entity, separate from the individuals who own it, and
which can engage in almost any type of business transaction in which a real person
could occupy himself or herself.
Advantages:
1. It enjoys perpetual life without regard to any change in the person of its
owners, the stockholders
2. The stockholders are not liable for the debts of the corporation
3. Relatively easier to obtain large amounts of money for expansion, due to its
perpetual life
4. The ownership in the corporation is readily transferred
5. Authority is easily delegated by the hiring of managers
Disadvantages:
1. The activities of a corporation are limited to those stated in its charter
2. Relatively complicated in formation and administration
3. There is a greater degree of governmental control as compared to other types
of business organizations

Capitalization of a Corporation
The capital of a corporation is acquired through the sale of stock. There are two principal types
of capital stock:
a. Common Stock – represents ordinary ownership without special guarantees of return.
Common stockholders have certain legal rights, among which are the following:
 Advantages:
1. Vote at stockholder’s meeting
2. Elect directors and delegates to them power to conduct the affairs of the
business
3. Sell or dissolve the corporation
4. Make and amend the by-laws of the corporation
5. Subject to government approval, amend, or change the charter or capital
structure
6. Participate in the profits
7. Inspect the books of the corporation
b. Preferred Stock – are guaranteed a definite dividend on their stocks. In case the
corporation is dissolved, the assets must be used to satisfy the claims of the preferred
stockholders before those of the holders of the common stock. Preferred stockholders
usually have the right to vote in meetings, but not always.

Capital Financing – is defined as the methods businesses use to raise money, such as debt
financing and equity financing. In debt financing, you borrow money to pay for business
operations. With equity financing, you sell an ownership stake in the company — by
issuing stock, for example.

Bond – is a certificate of indebtedness of a corporation usually for a period not less than ten
years and guaranteed by a mortgage on certain assets of the corporation or its subsidiaries.
Bonds are issued when there is need for more capital such as for expansion of the plant or
the services rendered by the corporation.

Face of the Bond – or per value of a bond is the amount stated on the bond. When the face
value has been repaid, the bond is said to have been retired or redeemed. The bond rate is
the interest rate quoted on the bond. And this can be classified as follows:
a. Registered Bonds – the name of the owner of this bond is recorded on the record
books of the corporation and interest payments are sent to the owner periodically
without any action on his part.
b. Coupon Bonds – have coupon attached to the bond for each interest payment that
will come due during the life of the bond. The owner of the bond can collect the
interest due by surrendering the coupon to the office of the corporation or at
specified banks.

Bond Retirement by Sinking Fund

𝐹
𝐴= = 𝐹 (𝐴⁄𝐹 , 𝑖%, 𝑛)
𝐹 ⁄𝐴 , 𝑖%, 𝑛

𝐼 = 𝐹𝑟
Where:
𝐴 = periodic deposit to the sinking fund
𝐹 = accumulated amount, the amount needed to retire the bond
 𝑖 = rate of interest in the sinking fund
𝑟 = bond rate per period
𝐼 = interest on the bonds per period
𝐴 + 𝐼 = total periodic expense

Problem 1.) A bond issue of ₱200,000 in 10-years bonds, in ₱1,000 units paying 16% nominal
interest in semiannual payments, must be retired by the use of sinking fund that earns 12%
compounded semiannually. What is the total semiannual expense?
Solution:
16% 12%
𝐹 = ₱200,000 𝑟= = 8% 𝑖= = 6% 𝑛 = (10)(2) = 20
2 2

200,000 200,000
𝐴= = = ₱𝟓, 𝟒𝟑𝟕
𝐹 ⁄𝐴 , 6%, 20 36.7856
𝐼 = 𝐹𝑟 = (200,000)(0.08) = ₱𝟏𝟔, 𝟎𝟎𝟎

Total semiannual expense = 5,437 + 16,000 = ₱𝟐𝟏, 𝟒𝟑𝟕

Bond Value – is the present worth of all future amounts that are expected to be received through
ownership of the bond.

𝑃 = 𝐹𝑟(𝑃⁄𝐴 , 𝑖%, 𝑛) + 𝐶 (𝑃 ⁄𝐹 , 𝑖%, 𝑛)

1 − (1 + 𝑖 )−𝑛
𝑃 = 𝐹𝑟 [ ] + 𝐶 (1 + 𝑖 )−𝑛
𝑖

Where:
𝐹 = face, or par, value
𝐶 = redemption or disposal price (often equal to F)
𝑟 = bond rate per period
𝑛 = number of periods before redemption
𝑖 = investment rate or yield per period
𝑃 = value of the bond n periods before redemption

Problem 2.) A man wants to make 14% nominal interest compounded semiannually on a bond
investment. How much should the man be willing to pay now for 12% ₱10,000-bond that
will mature in 10 years and pays interest semiannually?
Solution:
12% 14%
𝐹 = ₱10,000 𝑟= = 6% 𝑖= = 7% 𝑛 = (10)(2) = 20
2 2

𝐼 = 𝐹𝑟 = (10,000)(0.06) = ₱𝟔𝟎𝟎

𝑃 = 𝐹𝑟(𝑃 ⁄𝐴 , 𝑖%, 𝑛) + 𝐶 (𝑃 ⁄𝐹 , 𝑖%, 𝑛)

= 600(𝑃 ⁄𝐴 , 7%, 20) + 10,000(𝑃 ⁄𝐹 , 7%, 20)
 = 600(10.5940) + 10,000(0.2584)
= ₱𝟖, 𝟗𝟓𝟎

Problem 3.) Mr. Romualdo bought a bond having a face value of ₱1,000 for ₱970. The bond
rate was 14% nominal and interest payments were made to him semiannually for a total of
7 years. At the end of the seventh year, he sold the bond to a friend at a price that resulted
a yield of 16% nominal on his investment. What was the selling price?
Solution:
14% 16%
𝐹 = ₱1,000 𝑟= = 7% 𝑖= = 8% 𝑛 = (7)(2) = 14
2 2

𝐼 = 𝐹𝑟 = (1,000)(0.07) = ₱𝟕𝟎

𝑃 = 𝐹𝑟(𝑃 ⁄𝐴 , 𝑖%, 𝑛) + 𝐶 (𝑃 ⁄𝐹 , 𝑖%, 𝑛)

970 = 70(𝑃 ⁄𝐴 , 8%, 14) + 𝐶 (𝑃⁄𝐹 , 8%, 14)
970 = 70(8.2442) + 𝐶 (0.3405)
𝑪 = ₱𝟏, 𝟏𝟓𝟑. 𝟗𝟎

Problem 4.) A ₱1,000 bond which will mature in 10 years and with a bond rate of 8% payable
annually is to be redeemed at par at the end of this period. If it is sold at ₱1,030, determine
the yield at this price.
Solution:
𝐶 = ₱1,000 𝑃 = ₱1,030 𝑟 = 8% 𝑛 = 10

𝐼 = 𝐹𝑟 = (1,000)(0.08) = ₱𝟖𝟎

𝑃 = 𝐹𝑟(𝑃 ⁄𝐴 , 𝑖%, 𝑛) + 𝐶 (𝑃 ⁄𝐹 , 𝑖%, 𝑛)

1,030 = 80(𝑃 ⁄𝐴 , 8%, 10) + 1,000(𝑃 ⁄𝐹 , 𝑖%, 10)
Try 𝑖 = 8%
𝑃 = 80(𝑃⁄𝐴 , 8%, 10) + 1,000(𝑃 ⁄𝐹 , 8%, 10)
= 80(6.7101) + 1,000(0.4632) = ₱𝟏, 𝟎𝟎𝟎. 𝟎𝟏
Try 𝑖 = 7%
𝑃 = 80(𝑃⁄𝐴 , 7%, 10) + 1,000(𝑃 ⁄𝐹 , 7%, 10)
= 80(7.0236) + 1,000(0.5083) = ₱𝟏, 𝟎𝟕𝟎. 𝟏𝟗

8% 1,000.01
1% [ 𝑖 1,1030.00 ] 70.18
𝑥[ ] 40.19
7% 1,070.19
4.19
𝑥= = 0.57
70.18
𝒊 = 𝟕. 𝟓𝟕%
_____________________________________________

References/Additional Resources/Readings

C. Park (2013). Fundamentals of Engineering Economics, 3rd ed., Pearson Education, Inc.

H. Sta. Maria (n.d.). Engineering Economy 3rd ed., National Bookstore, Inc.

https://www.accountingformanagement.org/sum-of-the-years-digits-method/
Activity Sheet
ACTIVITY 4

Name: ______________________Course/Year/Section: ___________ Score: _________

Direction: Identify the following.

________________ 1. The present worth of all future amounts that are expected to be received
through ownership of the bond.
________________ 2. The name of the owner of this bond is recorded on the record books of
the corporation and interest payments are sent to the owner periodically
without any action on his part.
________________ 3. A certificate of indebtedness of a corporation usually for a period not
less than ten years and guaranteed by a mortgage on certain assets of
the corporation or its subsidiaries.
________________ 4. The methods businesses use to raise money, such as debt financing and
equity financing. In debt financing, you borrow money to pay for
business operations.
________________ 5. Represents ordinary ownership without special guarantees of return.
________________ 6. The simplest form of business organization, wherein a person uses his
or her own capital to establish a business and is the sole owner.
________________ 7. A distinct legal entity, separate from the individuals who own it, and
which can engage in almost any type of business transaction in which
a real person could occupy himself or herself.
________________ 8. An association of two or more persons for the purpose of engaging in
a business for profit.
________________ 9. Coupon attached to the bond for each interest payment that will come
due during the life of the bond.
________________ 10. Are issued when there is need for more capital such as for expansion
of the plant or the services rendered by the corporation.

Direction: Solve the following.

1. A corporation sold an issue of 20-year bonds, having a total face value of ₱10,000,000
for ₱9,500,000. The bonds bear interest at 16%, payable semiannually. The company wishes
to establish a sinking fund for retiring the bond issue and will make semiannual deposits that
will earn 12%, compounded semiannually. Compute the annual cost for interest and
redemption of these bonds. (Ans. ₱1,730,000)

2. A company has issued 10-year bonds, with a face value of ₱1,000,000, in ₱1,000 units.
Interest at 16% is paid quarterly. If an investor desire to earn 20% nominal interest on 100,000
worth of these bonds, what would the selling price have to be? (Ans. ₱82,836)

3. A ₱1,500 bond which will mature in 10 years and with a bond rate of 15% payable
annually is to be redeemed at par at the end of this period. If it is sold now for ₱1,390, determine
the yield at this price. (Ans. 16.56%)
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