Eng Econ Im 2 PDF

Republic of the Philippines
NUEVA VIZCAYA STATE UNIVERSITY

Bayombong, Nueva Vizcaya
INSTRUCTIONAL MODULE
IM No.: ENG ECON – 1STSEM-2020-2012
COLLEGE OF ENGINEEERING
DEGREE COURSE NO.

BSCE ENG ECON
PROGRAM
SPECIALIZATION COURSE TITLE ENGINEERING ECONOMICS
YEAR LEVEL 2nd Year TIME FRAME 6 WK NO. 2 IM NO. 2
I. UNIT TITLE/CHAPTER TITLE

1. Principles of Money-time Relationships
II. LESSON TITLE
3.1. Terminologies
3.2. Notation and Cash Flow
3.3. Interest Formulas for Discrete Cash Flows
3.4. Nominal and Effective Interest Rate
3.5. Additional Readings
III. LESSON OVERVIEW
IV. DESIRED LEARNING OUTCOMES
V. LESSON CONTENT
1. PRINCIPLES OF MONEY-TIME RELATIONSHIPS
3.1. TERMINOLOGIES
Capital – refers to wealth in the form of money or property that can be used to produce
more wealth.
The Concept of Time Value of Money – “Money makes money”. This is true because
if we invest money today, by tomorrow we will have accumulated more money that what
we had originally invested. And also if you borrow money today you will have to pay in
the future an amount that is larger that what you have originally owed. This change in
the amount of money over a given time period is called time value of money”.
Equity capital – is owned by individuals who have invested their money or property in a
business project or venture in the hope of receiving a profit and sometimes in exchange
for a share of ownership in the company. Equity financing allows a business to obtain
funds without incurring debt or having to repay a specific amount of money at a
particular time.
Debt Capital – also called borrowed capital, is represented by funds borrowed by a

business that must be repaid over a period of time, usually with interest. Debt financing
NVSU-FR-ICD-05-00 (081220) Page 1 of 13
can be either short-term, with full repayment due in less than one year, or long-term,
with repayment due over a period greater than one year.
Return On Capital - measures of how effectively a company uses the money (borrowed
or owned) invested in its operations.
Interest - The term "interest" is used to indicate the rent paid for the use of money. It is
also used to represent the percentage earned by an investment in a productive
operation. From the lender's point of view, the interest is the income produced by the
money which he has lent. From the borrower's point of view, interest is the amount of
money paid for the use of borrowed capital. The percentage of money charge as
interest is called as interest rate.
Simple Interest
The interest is said to be simple interest if the interest to be paid is directly proportional
to the length of time the amount or principal is borrowed. The principal is the amount of
money borrowed or invested.
Total interest (I) is computed by the formula:
I = (P) (n) (i) where: P = principal amount lent or borrowed

n = number of interest period (ex. years) i = interest rate per interest period
The total amount , F to be repaid at the end of N interest period is F = P + I of F = P[1 +

(n x i)] Sample Problems.
1. Suppose that P1,000 is borrowed at a simple interest rate of 18% per annum. At
the end of one year, the interest would be:
I = (P) (n) (i)

I = 1,000 (1) (0.18) = P 180
2. Michelle invested $5000.00 in mutual fund with the interest rate of 4.8%. How
much interest would she earn after 2 years?
P = $5000.00 ; i= 4.8% ; n= 2
I = (P) (n) (i)

I = ($5000.00)(4.8%)(2) = $480.00
Hence, Michelle would earn $480 after 2 years.
3. Jeff has one savings account with the interest rate of 3.3%, and one money
market account with the interest rate of 5.1% in a bank. If he deposits $1,200.00 to the
savings account, and $1,800.00 to the money market account, how much money will he
have after 6 years?
Savings account: P = $1,200.00 i = 3.3% n= 6 Money market account: P = $1,800.00 i

= 5.1% n = 6
I = ($1,200.00) (3.3%) (6)] I = 237.60 = ($1,800.00)[1+(5.1%)(6)]
= ($1,800.00)(1.306)
= $2,350.80
F=P+I
F = $1,200.00 + 237.60
F = $1,437.60 Total amount:
$1437.60 + $2350.80
= $3,788.40
Hence, Jeff will have $3,788.40 after 6 years.
Compound Interest
• Whenever the interest charge for any interest period is based on the remaining
principal amount plus any accumulated interest chargers up to the beginning of that
period, the interest is said to be compound.
• Compound interest calculations apply to investments where the amount of
interest is calculated on the present balance of the account.
Sample Problem.
For instance, if you invested $100 in a bank with an interest rate of 10% compounded
annually (once per year), then in the first year of your investment you would earn $10. If
this were simple interest, you would continue to earn $10 per year for the period of your
investment. However, since the interest is compounded, you earn interest on your
interest. The amount of compound interest for the first interest period is the same as for
simple interest. However, for further interest periods, the amount of compound interest
increases to an amount greater than simple interest.
To illustrate:
Simple Interest Compound Interest
Year 1 $100 * 10% = $10 $100 * 10% = $10
Year 2 $100 * 10% = $10 $110 * 10% = $11
Year 3 $100 * 10% = $10 $121 * 10% = $12.10
Total Interest $30 $33.10
From the illustration above, you can see that under simple interest payments, a yearly
sum of $10 is gained through interest. For each year of the loan period, $10 is earned.
However, under compound interest payments, the yearly interest is added to the
principle for the next period. This has the effect of increasing interest earned each year
for the duration of the period (note: in example above, $33.10 earned from compound
interest versus $30 earned from simple interest).

VI. LEARNING ACTIVITIES

VII. EVALUATION
VIII. ASSIGNMENT
IX. REFERENCES
Sepulveda, J., Souder, W., Gottfried, S.. Theory and Problems of Engineering
Economics. McGraw-Hill Companies:USA. 1984
Curesma, F. and Cabanayan, L., Compiled Lecture in Engineering Economics.
Central Luzon State University: Nueva Ecija, Philippines. 2012

ADDITIONAL READINGS
Basic Concepts
1.1 INTEREST
Interest is a fee that is charged for the use of someone else's money. The size of the fee will depend
upon the total amount of money borrowed and the length of time over which it is borrowed.
Example 1.1 An engineer wishes to borrow $20 000 in order to start his own business. A bank will lend
him the money provided he agrees to repay $920 per month for two years. How much interest is he being
charged?
The total amount of money that will be paid to the bank is 24 x $920 = $22 080. Since the original loan
is only $20 000, the amount of interest is $22 080 - $20 000 = $2080.
Whenever money is borrowed or invested, one party acts as the lender and another party as the
borrower. The lender is the owner of the money, and the borrower pays interest to the lender for the use of
the lender's money. For example, when money is deposited in a savings account, the depositor is the lender
and the bank is the borrower. The bank therefore pays interest for the use of the depositor's money. (The
bank will then assume the role of the lender, by loaning this money to another borrower, at a higher interest
rate.)
1.2 INTEREST RATE
If a given amount of money is borrowed for a specified period of time (typically, one year), a
I
certain percentage of the money is charged as interest. This percentage is called the interest rate.
Example 1.2 (a) A student deposits $1000 in a savings account that pays interest at the rate of 6% per
year. How much money will the student have after one year? (b) An investor makes a loan of $5000, to be
repaid in one lump sum at the end of one year. What annual interest rate corresponds to a lump-sum
payment of $5425?
(a) The student will have his original $1000, plus an interest payment of 0.06 x $1000 = $60. Thus, the
student will have accumulated a total of $1060 after one year. (Notice that the interest rate is expressed
as a decimal when carrying out the calculation.)
(b) The total amount of interest paid is $5425 - $5000 = $425. Hence the annual interest rate is
a
Interest rates are usually influenced by the prevailing economic conditions, as well as the degree of
risk associated with each particular loan.
1.3 SIMPLE INTEREST

Simple interest is defined as a fixed percentage of the principal (the amount of money borrowed),
multiplied by the life of the loan. Thus,
where I =total amount of simple interest

n =life of the loan
i = interest rate (expressed as a decimal)
P = principal
It is understood that n and i refer to the same unit of time (e.g., the year).
2 BASIC CONCEPTS [CHAP. 1
Normally, when a simple interest loan is made, nothing is repaid until the end of the loan period; then, both
the principal and the accumulated interest are repaid. The total amount due can be expressed as
Example 1.3 A student borrows $3000 from his uncle in order to finish school. His uncle agrees to charge
him simple interest at the rate of 5% per year. Suppose the student waits two years and then repays the entire
loan. How much will he have to repay?
By (1.2), F = $3000[1+ (2)(0.055)] = $3330.
1.4 COMPOUND INTEREST
When interest is compounded, the total time period is subdivided into several interest periods (e.g., one
year, three months, one month). Interest is credited at the end of each interest period, and is allowed to
accumulate from one interest period to the next.
During a given interest period, the current interest is determined as a percentage of the total amount owed
(i.e., the principal plus the previously accumulated interest). Thus, for the first interest period, the interest is
determined as
and the total amount accumulated is
For the second interest period, the interest is determined as
I2 = iFl= i (1 + i)P
and the total amount accumulated is

F2= P + I, + I2= P + iP + i(1 + i)P = P ( 1 +')i
For the third interest period,
I 3 = i(1 + i)2P F3= P ( 1 S i)3
and so on. In general, if there are n interest periods, we have (dropping the subscript):

which is the so-called law of compound interest. Notice that F, the total amount of money accumulated,
increases exponentially with n, the time measured in interest periods.
Example 1.4 A student deposits $1000 in a savings account that pays interest at the rate of 6% per year,
compounded annually. If all of the money is allowed to accumulate, how much will the student have after 12
years? Compare this with the amount that would have accumulated if simple interest had been paid.
BY(1.31,
F = $1000(1+ 0.06)" = $2012.20
Thus, the student's original investment will have more than doubled over the 12-year period.
If simple interest had been paid, the total amount that would have accumulated is determined by (1.2) as
F = $1000[1+ (12)(0.06)] = $1720.00
1.5 THE TIME VALUE OF MONEY
Since money has the ability to earn interest, its value increases with time. For instance, $100 today is
equivalent to
F = $100(1+ 0.07)5= $140.26
five years from now if the interest rate is 7% per year, compounded annually. We say that the future worth of
$100 is $140.26 if i = 7% (per year) and n = 5 (years).
Since money increases in value as we move from the present t o the future, it must decrease in value as we
move from the future t o the present. Thus, the present worth of $140.26 is $100 if i = 7% (per year) and n =
5 (years).
Example 1.5 A student who will inherit $5000 in three years has a savings account that pays 5% per year,
compounded annually. What is the present worth of the student's inheritance?
Equation (1.3) may be solved for P, given the value of F:
The present worth of $5000 is $4258.07 if i = 5$%, compounded annually, and n = 3.
1.6 INFLATION
National economies frequently experience inflation, in which the cost of goods and services increases from
one year t o the next. Normally, inflationary increases are expressed in terms of percentages which are
compounded annually. Thus, if the present cost of a commodity is PC, its future cost, FC, will be
F C = PC(l + A)" (1.4)
where A = annual inflation rate (expressed as a decimal)
n = number of years
Example 1.6 An economy is experiencing inflation at the rate of 6% per year. An item presently costs
$100. If the 6% inflation rate continues, what will be the price of this item in five years?
By (1.4), FC = $100(1+ 0.06)' = $133.82.
In an inflationary economy, the value (buying power) of money decreases as costs increase. Thus,
P
F=-
(1 + A)"
where F is the future worth, measured in today's dollars, of a present amount P.
Example 1.7 An economy is experiencing inflation at an annual rate of 6%. If this continues, what will
$100 be worth five years from now, in terms of today's dollars?
From (1.5),
Thus $100 in five years will be worth only $74.73 in terms of today's dollars. Stated differently, in five
years $100 will be required to purchase the same commodity that can now be purchased for $74.73.
If interest is being compounded at the same time that inflation is occurring, then the future worth can be
determined by combining (1.3) and (1.5):
or, defining the composite interest rate,we have
F=P(l+O)"
Observe that 0 may be negative.
Example 1.7 An engineer has received $10 000 from his employer for a patent disclosure. He has decided to
invest the money in a 15-year savings certificate that pays 8% per year, compounded annually. What will be the
final value of his investment, in terms of today's dollars, if inflation continues at the rate of 6% per year?
A composite interest rate can be determined from (1.6):
Substituting this value into (1.7), we obtain
F = $10 000(1+ 0.0189)15= $13 242.61

(If more significant figures are included in the value for 8, the future value $13 236.35 is obtained.)
1.7 TAXES
In most situations, the interest that is received from an investment will be subject to taxation. Suppose that
the interest is taxed at a rate t, and that the period of taxation is the same as the interest period (e.g., one year).
Then the tax for each period will be T = tip, so that the net return to the investor (after taxes) will be
If the effects of taxation and inflation are both included in a compound interest calculation, (1.7) may still be
used to relate present and future values, provided the composite interest rate is redefined as
Example 1.8 Refer to Example 1.7. Suppose the engineer is in the 32% tax bracket, and is likely to remain there
throughout the lifetime of the certificate. If inflation continues at the rate of 6% per year, what will be the value
of his investment, in terms of today's dollars, when the certificate matures?
Let us assume that the engineer is able to invest the entire $10 000 in a savings certificate and that the 32%
tax bracket includes all federal, state, and local taxes. By (1.9),
and (1.7) then gives

Because of the combined effects of inflation and taxation, I3 is negative, and the engineer ends up with less real
purchasing power after 15 years than he has today. (To make matters worse, the engineer will most likely have
to pay taxes on the original $10 000, substantially reducing the amount of money available for investment.)
The subject of taxation is considered in much greater detail in Chapter 11.
1.8 CASH FLOWS
A cash flow is the difference between total cash receipts (inflows) and total cash disbursements (outflows)
for a given period of time (typically, one year). Cash flows are very important in engineering economics
because they form the basis for evaluating projects, equipment, and investment alternatives.
The easiest way to visualize a cash flow is through a cash flow diagram, in which the individual cash flows
are represented as vertical arrows along a horizontal time scale. Positive cash flows (net inflows) are
represented by upward-pointing arrows, and negative cash flows (net outflows) by downward-pointing arrows;
the length of an arrow is proportional to the magnitude of the cor-responding cash flow. Each cash flow is
assumed to occur at the end of the respective time period.
Example 1.9 A company plans to invest $500 000 to manufacture a new product. The sale of this product is
expected to provide a net income of $70 000 a year for 10 years, beginning at the end of the first year. Figure
1-1 is the cash flow diagram for this proposed project. Notice that the initial $500 000 investment is represented
by a downward-pointing arrow located at the end of year 0 (i.e., at the beginning of year 1). Each annual net
income ($70 000) is indicated by an upward-pointing arrow located at the end of the corresponding year.

In a lender-
borrower situation, an
inflow for the one is an
outflow for the other.
Hence, the cash flow
diagram for the lender
will be the mirror
image in the time line
of the cash flow
diagram for the
borrower.

Eng Econ Im 2 PDF

Uploaded by

Copyright:

Available Formats

Eng Econ Im 2 PDF

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Eng Econ Im 2 PDF

Uploaded by

Copyright:

Available Formats

Republic of the Philippines

NUEVA VIZCAYA STATE UNIVERSITY

IM No.: ENG ECON – 1STSEM-2020-2012

DEGREE COURSE NO.

I. UNIT TITLE/CHAPTER TITLE

IV. DESIRED LEARNING OUTCOMES

Debt Capital – also called borrowed capital, is represented by funds borrowed by a

Total interest (I) is computed by the formula:

I = (P) (n) (i) where: P = principal amount lent or borrowed

The total amount , F to be repaid at the end of N interest period is F = P + I of F = P[1 +

I = (P) (n) (i)

I = (P) (n) (i)

Hence, Michelle would earn $480 after 2 years.

Savings account: P = $1,200.00 i = 3.3% n= 6 Money market account: P = $1,800.00 i

NVSU-FR-ICD-05-00 (081220) Page 3 of 13

VI. LEARNING ACTIVITIES

NVSU-FR-ICD-05-00 (081220) Page 4 of 13

1.2 INTEREST RATE

1.3 SIMPLE INTEREST

where I =total amount of simple interest

2 BASIC CONCEPTS [CHAP. 1

By (1.2), F = $3000[1+ (2)(0.055)] = $3330.

1.4 COMPOUND INTEREST

and the total amount accumulated is

For the second interest period, the interest is determined as

and the total amount accumulated is

For the third interest period,

I 3 = i(1 + i)2P F3= P ( 1 S i)3

NVSU-FR-ICD-05-00 (081220) Page 7 of 13

F = $1000(1+ 0.06)" = $2012.20

F = $1000[1+ (12)(0.06)] = $1720.00

1.5 THE TIME VALUE OF MONEY

F = $100(1+ 0.07)5= $140.26

Equation (1.3) may be solved for P, given the value of F:

The present worth of $5000 is $4258.07 if i = 5$%, compounded annually, and n = 3.

F C = PC(l + A)" (1.4)

where A = annual inflation rate (expressed as a decimal)

By (1.4), FC = $100(1+ 0.06)' = $133.82.

where F is the future worth, measured in today's dollars, of a present amount P.

Observe that 0 may be negative.

Substituting this value into (1.7), we obtain

F = $10 000(1+ 0.0189)15= $13 242.61

NVSU-FR-ICD-05-00 (081220) Page 10 of 13

and (1.7) then gives

NVSU-FR-ICD-05-00 (081220) Page 11 of 13

The subject of taxation is considered in much greater detail in Chapter 11.

1.8 CASH FLOWS

NVSU-FR-ICD-05-00 (081220) Page 12 of 13

NVSU-FR-ICD-05-00 (081220) Page 13 of 13

You might also like