Engineering Economy

Ma. Leona Maye B. Pepito, ME

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Engineering Economy involves the systematic evaluation of the
economic merits of proposed solutions to engineering problems. To
be economically acceptable (i.e., affordable), solutions to
engineering problems must demonstrate a positive balance of long-
term benefits over long-term costs, and they must also:
• promote the well-being and survival of an organization,
• embody creative and innovative technology and ideas,
• permit identification and scrutiny of their estimated outcomes, and
• translate profitability through a valid and acceptable measure of
merit.

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Annuity
- series of equal payments occuring at
equal intervals of time.

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 Types of Annuity:

1. Ordinary Annuity - payments occur at the end

of each period.
2. Annuity Due - payments occur at the
beginning of each period.
3. Deferred Annuity - does not begin until a
given time interval has
passed.
4. Perpetuity - an annuity that continues
indefinitely.

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Ordinary Annuity

The equal payments are made at the end of each compounding

period starting from the first compounding period.

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 Sample Problems:
1. What is the present value of an annuity of Php2,000
per year, with the first cash flow received three years from
today and the last one received 8 years from today? Use
a interest rate of eight percent.

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2. How much must be deposited at 6% each year
beginning on Jan.1 - year 1, in order to accumulate
Php 5,000.00 on the date of the last deposit, Jan.1 -
year 6?

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3. A company has to replace a present facility after
15 years at an outlay of Php 5,000.00. It plans to
deposit an equal amount at the end of every year for
the next 15 years at an interest rate of 18%
compounded annually. Find the equivalent amount
that must be deposited at the end of every year for
the next 15 years.

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Seatwork:
1. A person who is now 35 years old is planning for
his retired life. He plans to invest an equal sum of
Php 10,000 at the end of every year for the next 25
years starting from the end of the next year. The
bank gives 20% interest rate, compounded annually.
Find the maturity value of his account when he is 60
years old.
2. You borrowed Php 15,000 from your credit union
to purchase a used car. The interest rate on your loan
is 0.25% per month and you will make a total of 36
monthly payments. What is your monthly payment?

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 Types of Annuity:

1. Ordinary Annuity - payments occur at the end

of each period.
2. Annuity Due - payments occur at the
beginning of each period.
3. Deferred Annuity - does not begin until a
given time interval has
passed.
4. Perpetuity - an annuity that continues
indefinitely.

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Annuity Due
a. Present Worth:
 1  i  n  1  1 
P  A   A
 1  i 
n 1
i 
where, 
1  i  n  1  1  is the equal payment series
 
 1  i  n 1
i  present worth factor.
b. Future Worth:
 1  i  n  1  1 
F  A   A
 i 
where,  1  i  n  1  1  is the equal payment series
  compounded amount factor.
 i
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Annuity Due
Example no.1 :
Engr. Sison borrows Php 100,000.00 at 10% effective
annual interest. He must pay back the loan over 30years
with uniform monthly payments due on the first day of
each month. How much does Engr. Sison pay each month?
Given:
P=100,000
i =10%/12
n=30 years*12

Required: A

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Annuity Due
Example no.1 :

Solution:  1  i  n  1  1 
P  A   A
 1  i  n 1
i 

  0 . 10 
( 30 *12 )  1

 1   1 
12
100 , 000  A     A
 0 . 10 
( 30 *12 )  1
 0 . 10  
 1    
  12   12 

A  Php 870 . 32

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Annuity Due
Example no.2 :
A man wishes to have Php 35,000 when he retires
15years from now. If he can expect to receive 4% annual
interest, how much should he set aside in each of 15
equal annual beginning of year deposits?

Given:
F= 35,000
i = 4%
n=15 years
Required: A
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Annuity Due
Example no.2 :

Solution:
 1  i n 1  1
F  A  A
 i 

 1  0.04151  1
35,000  A  A
 0.04 
A  Php 1680 . 71

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Annuity Due
Example no.3 :
A man owes Php10,000.00 with interest at 6% payable
semi-annually. What equal payments at the beginning of
each 6-months for 8 years will discharge his debt?

Given:
P= 10,000
i = 6%/2
n=8 years*2
Required: A

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Annuity Due
Example no.3 :

Solution:
 1  i n 1  1 
P  A  A
 1  i  i 
n 1

  0 . 06 
( 8* 2 ) 1

  1    1 
 2 
10 , 000  A   A
 0 . 06 
( 8* 2 ) 1
 0 . 06  
 1    
 2   2 

A  Php 772 . 92

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Types of Annuity:

1. Ordinary Annuity - payments occur at the

end of each period.
2. Annuity Due - payments occur at the
beginning of each period.
3. Deferred Annuity - does not begin until a
given time interval has
passed.
4. Perpetuity - an annuity that continues
indefinitely.

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 Deferred Annuity
Deferred Annuity - an annuity that does not begin
until a given time interval has passed.
Period of Deferral - time between the purchase of an
annuity and the start of the
payments for the deferred annuity.

Solving the Present Worth:

 1  1  i  ( k  n )   1  1  i  k 
P  A   A 
 i   i  Where;
k=period of deferral
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Deferred Annuity
Example no.1:
A man loans Php187,400 from a bank with interest at
5% compounded annually. He agrees to pay his
obligations by paying 8 equal annual payments, the
first being due at the end of 10yrs. Find the annual
payments.
Given:
P=187,400 i=5%
n=8 k=9

Required: A
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Deferred Annuity
Example no.1:
Solution: (using deferral method)
 1  1  i  ( k  n )   1  1  i  k 
P  A   A 
 i   i 

 1  1  0 .05  ( 9  8 )   1  1  0 .05  9 
187400  A    A 
 0 . 05   0 . 05 

A  Php 44 , 980 . 56

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Deferred Annuity
Example no.1:
Solution: (using present worth method)
 1  i n  1 
P1  A  
 1  i  i 
n

 1  0 .05 8  1 
P2  A  
 1  0 .05  ( 0 .05 ) 
8

P2  6 .4632 A
P2  P 1  i 
n

6 .4632 A  (187400 ) 1  0 .05 

9

A  Php 44 , 980 . 65
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Deferred Annuity
Example no.2 :
A parent on the day the child is born wishes to
determine what lump sum would have to be paid
into an account , in order to withdraw Php20,000.00
each on the child's 18th, 19th, 20th and 21st
birthday?with an annual 5% interest.
Given:
A=20,000
i =5%
n=4 years k=17yrs

Required: P MLMPepito2020
 Deferred Annuity
Example no.2:
Solution:(using deferral method)
 1  1  i  ( k  n )   1  1  i  k 
P  A   A 
 i   i 

 1  1  0 .05  (17  4 )   1  1  0 .05  17 

P  20 ,000    20 ,000  
 0 . 05   0 . 05 

P  Php 30 , 941 . 73

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Deferred Annuity
Example no.2 :
Solution: (using present worth method)
 1  i n  1 
P1  A  
 1  i  n
i 
 1  0 .05 4  1 
P2  20 ,000  
 1  0 .05  ( 0 .05 ) 
4

P2  3 .5459 ( 20 ,000 )
P2  Php 70 ,919 .01
P2  P 1  i 
n

Php 70 ,919 .01  P 1  0 .05 

17

P  Php 30 , 941 . 73
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Types of Annuity:

1.Ordinary Annuity - payments occur at the end

of each period.
2.Annuity Due - payments occur at the
beginning of each period.
3.Deferred Annuity - first payment occurs later
than, at the end of the first
period.
4.Perpetuity - an annuity that continues
indefinitely.

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Perpetuity
a. Present Worth:

A
P
i

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Perpetuity
Example no.1:
Calculate the present value on Jan.1, 2020 of a
perpetuity paying Php1,000.00 at the end of each
month starting from Jan.2020. The monthly interest
rate is 8%.

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Perpetuity
Example no.1:
Given:
Nominal Interest= 8%; m=12
Perpetuity= Php 1,000
Solution:
 i 
m
A
ie   1  m  1 P 
 m  i
12 1 , 000
 0 . 08  P 
ie   1   1 0 . 083
 12 
i e  0 . 083 P  Php12,048.20

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Nominal interest rate - cost of borrowed money
which specifies the rate of interest and the
number of interest period.
Effective interest rate - actual rate of interest on
the capital and is equal to the nominal rate if
compounded annually.

m
 in 
ie   1    1
 m
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Perpetuity
Example no.2:
Find the present value in pesos, of a perpetuity of
Php15,000.00 payable semi-annually if money is
worth 8% compounded quarterly.

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Perpetuity
Example no.2:
Given:
Effective Rate Quarterly= 8%; n=4
Effective Rate Semi-Annual=im; m=2
Perpetuity= Php 15,000
Solution: n m
 i   i  A
1  n   1  m  P 
 n   m  i
4 2 15 , 000
 0 . 08   i  P 
1    1  m  0 . 0404
 4   2 
P  Php 371 , 287 . 13
i m  0 . 0808
im 0 . 0808
i    0 . 0404
2 2 MLMPepito2020
Compounded Continuously
a. Present Worth:
 1  e  rn 
P  A r 
 e 1 
b. Future Worth:
 e rn  1 
F  A r 
 e 1 

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Compounded Continuously
Example no.1:
Six hundred pesos is deposited each year into a savings
bank account that pays 6% nominal interest,
compounded continuously. How much will be in the
account at the end of 8years.

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Compounded Continuously
Example no.1:
Given: Required: F
A= 600
i = 6%
n= 8
Solution:  e rn
 1
F  A r 
 e  1 
 e 0 . 06 * 8  1 
F  600  0 . 06 
 e  1 
F  Php 5MLMPepito2020
, 977 . 77
Compounded Continuously
Example no.2:
A man borrows Php100,000 at a rate of 6%
compounded continuously for 5 years. How much
must he pay annually if money is compounded
continuously.

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Compounded Continuously
Example no.2:
Given: Required: A
P= 100,000
i = 6%
n= 5
Solution: 1  e  rn 
P  A r 
 e  1 
100 , 000
A 
 1  e  ( 0 . 06 * 5 ) 
 e 0 . 06  1 
 
A  Php 23 , 858MLMPepito2020
. 37
Uniform Series of Payments
a. Present worth of equal series of payments:
 1  i  n  1 
P  A 
 1  i  i 
n

b. Future worth of equal series of payments:

 1  i  n  1 
F  A  
 i 

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Uniform Series of Payments
a. Present worth of equal series of payments:
 1  i  n  1 
P  A 
 1  i  i 
n

b. Future worth of equal series of payments:

 1  i  n  1 
F  A  
 i 

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 Uniform Series of Payments
c. Periodic payment for a series whose initial amount is “P”:
P 1  i  i
n
A  (Periodic Payment)
1  i   1
n

Equal payment series capital recovery factor  1  i  n

i
1  i  n  1

d. Periodic payment of a series whose sum is “F”:

Fi (Periodic Payment)
A 
1  i   1
n

i
Equal payment series sinking fund factor 
1  i
n
 1

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1.Compute the number of years in order that the capital recovery factor for a uniform
payment series be equal to 0.1424564 if money is worth 6% compounded semi-
annually?
2.In the purchase of a heater, a buyer pays Php 200.00 cash. He will discharge the
balance, principal and interest included at 18% payable monthly on the unpaid balance,
by payments of Php75.00 at the end of each month for a year. Find the cash value of
the heater.
3.Under a factory savings plan, a workman deposits Php25.00 at the beginning of each
month for 4 years, and the management guarantees accumulation at 6% compounded
monthly. How much stands to the workman’s credit at the end of 4 years?
4.Engr. Churva Ekek loan an amount of Php 100,000 at a local commercial bank at 10%
compounded annually. How much is his monthly payment if he is required to pay at the
beginning of the first day of the month for a period of 30 years.
5.ZYX Inc. plans to construct an additional building at the end of 10years for an
estimated cost of Php5,000,000.00, to accumulate this amount it will have equal year
end deposits in a fund earning 13%. However, at the end of the 5th year, it was decided
to have a larger building that originally intended to an estimated cost of
Php8,000,000.00. What should be the annual deposit for the last 5 years?

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1.Compute the number of years in order that the
capital recovery factor for a uniform payment
series be equal to 0.1424564 if money is worth
6% compounded semi-annually?

Equal payment series capital recovery factor 

1  i  n i
1  i  n  1
(2)n
 0 . 06  0 . 06
1  
2  2
0.1424564   (2)n
 0 . 06 
1   1
 2 

n  4 yrs

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2.In the purchase of a heater, a buyer pays Php
200.00 cash. He will discharge the balance, principal
and interest included at 18% payable monthly on
the unpaid balance, by payments of Php75.00 at the
end of each month for a year. Find the cash value of
the heater.
 1  i   1 
n
P  A 
 1  i  i 
n

  0 . 18 
12

  1   1 
12 
P  ( 75 )   
 0 . 18 
12
0 . 18 
 1   x 
 12  12 
P  Php 818 . 06
Cash Value = Php200 + 818.06 = Php1018.06
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3.Under a factory savings plan, a workman deposits
Php25.00 at the beginning of each month for 4 years,
and the management guarantees accumulation at 6%
compounded monthly. How much stands to the
workman’s credit at the end of 4 years?
 1  i n 1  1
F  A  A
 i 
 0 . 06 
( 4 *12 )  1

 1    1
12 
F  ( 25 )     25
 0 . 06 
 12 
 

F  Php 1359 .21

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4.Engr. Churva Ekek loan an amount of Php 100,000
at a local commercial bank at 10% compounded
annually. How much is his monthly payment if he is
required to pay at the beginning of the first day of
the month for a period of 30 years.
 1  i n 1  1 
P  A  A
 1  i  i 
n 1

  0 .10 
(12 *30 ) 1

  1   1 
12 
100 ,000  A    A
 0 .10 
(12 *30 ) 1
0 .10 
  1   
 12  12 

A  Php 870 .32

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5.ZYX Inc. plans to construct an additional building at
the end of 10years for an estimated cost of
Php5,000,000.00, to accumulate this amount it will
have equal year end deposits in a fund earning 13%.
However, at the end of the 5th year, it was decided
to have a larger building that originally intended to
an estimated cost of Php8,000,000.00. What should
be the annual deposit for the last 5 years?
 1  i  n  1 
F  A 
 i 
 1  0 . 13 10  1 
5, 000 , 000  A  
 ( 0 . 13 ) 
A  Php 271 , 447 .78
MLMPepito2020
  1  i  n  1 
F1 st 5 yrs  A 
 i 
 1  0.135  1
F1st 5 yrs  271,447.78 
 0 . 13 
F1st 5 yrs  Php1,759,055.07

F  F1st 5 yrs (1  i ) n
F  1,759 ,055 .07 (1  0.13) 5
F  Php 3,240 ,944 .94

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Balance at the end of 10years (F10 )  8,000 ,000  ( F )
 8,000 ,000  (3,240 ,944 .94 )
 Php 4,759 ,055 .06

 1  i n  1 
F10  A  
 i 
 1  0 . 13 5  1 
4 , 759 , 055 . 06  A  
 0 . 13 
A  Php 734 , 391 . 41
Remaining annual payment for the last 5 years

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SEATWORK
1)If the loan was for 15 months at 16.8% interest a
year and the repayment on a loan was P12,100.00,
how much was the principal?
2)Determine the accumulated value of P2,000.00 in 5
years it is invested at 11% compounded quarterly.
3)What is the effective rate equivalent of 12%
compounded quarterly?
4)What rate compounded-quarterly is equivalent to
14% compounded semi-annually?
5)Find the number of years when P2,500.00 is
compounded to P5,800.00 if invested at 12%
compounded quarterly.
MLMPepito2020
 Sample Problems:
1. A piece of machinery can be bought for Php 10,000.00
cash or for Php 2,000.00 and payments of Php 750.00 per
year for 15 years. What is the annual interest rate for the
time payments?

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Uniform Gradient
a. Arithmetic Uniform Gradient
- if the increase in succeeding period is constant.
• Present Worth:
 1  i n  1 n 
P  G  n 
 1  i  i 1  i  i 
n 2

• Future Worth:
 1  i n  1 n 
F  G 2
 
i
 MLMPepito2020 i
Uniform Gradient
a. Arithmetic Uniform Gradient

Conversion diagram of an arithmetic gradient series to an equivalent uniform

annual series.

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Uniform Gradient
• Equivalent Annual Amount:

1 n 
A  G  
i 1  i   1 
n

MLMPepito2020
Uniform Gradient
b. Geometric Uniform Gradient
-if the increase in succeeding is percentage
Present Worth :
 1 a  n
P  G 
 1  i 1  a  
where; 1 r
a 
1 i
r is the common ration or rate of increase or decrease in
disbursement
i is the interest rate
MLMPepito2020
Uniform Gradient
b. Geometric Uniform Gradient

Cash flow diagram of (a) increasing and (b) decreasing geometric gradient series
and present worth Pg.

MLMPepito2020
Uniform Gradient
a. Arithmetic Uniform Gradient
Example no.1:
A firm considering the installation of an automatic
data processing unit to handle some of its accounting
operations. Machines for that purpose may be
purchased for Php20,000.00 or may be leased for
Php8,000.00 for the first year and Php1,000.00 less
every year now and then until the end of the 4th year.
If money is worth 15%, is it advisable to rent or to
buy the machine?
MLMPepito2020
 Uniform Gradient
a. Arithmetic Uniform Gradient
Example no.1:
Given: A= 8,000 G=1,000 i=15% n=4yrs
Solution:
 1  i n  1 
PA  A  
 1  i  i 
n

 1  0 .15 4  1 
PA  (8,000 .00 )  
 1  0 .15  ( 0 .15 ) 
4

PA  Php 22 ,839 .83

MLMPepito2020
Uniform Gradient
a. Arithmetic Uniform Gradient
Example no.1, solution:
 1  i n  1 n 
PG  G   n 
 1  i  n 2
i 1  i  i
 1  0.154  1 4 
PG  1000   
 1  0.15 (0.15) 1  0.15 (0.15) 
4 2 4

PG  Php3,786.44
Ptotal  PA  PG
Ptotal  22 ,839 . 83  3, 786 . 44
Ptotal  Php 19 , 053 . 39 MLMPepito2020 →It is advisable to rent the machine.
Uniform Gradient
a. Arithmetic Uniform Gradient
Example no.2:
Find the cash present worth of all the cash
disbursements using gradient interest formulas if
money is worth 12% per annum. Annual cash
disbursements increase by Php1,000.00 every year
thereafter, until the end of the fifth year. The first
cash disbursement amounts to Php5,000.00.

MLMPepito2020
 Uniform Gradient
a. Arithmetic Uniform Gradient
Example no.2:
Given: A= 5,000 G=1,000 i=12% n=5yrs
Solution:
 1  i n  1 
PA  A  
 1  i  i 
n

 1  0 .12 5  1 
PA  ( 5,000 .00 )  
 1  0 .12  ( 0 .12 ) 
5

PA  Php 18 ,023 .88

MLMPepito2020
Uniform Gradient
a. Arithmetic Uniform Gradient
Example no.2, solution:
 1  i n  1 n 
PG  G   n 
 1  i  i 1  i  i 
n 2

 1  0.12 5  1 5 
PG  1000   
 1  0.12  (0.12) 1  0.12  (0.12) 
5 2 5

PG  Php6,397.02
Ptotal  PA  PG
Ptotal  18 , 023 . 88  6 ,397 . 02
Ptotal  Php 24 , 420 . 90MLMPepito2020
Uniform Gradient
b. Geometric Uniform Gradient
Example no.3:
Suppose that the maintenance for a piece of
equipment costs Php15,000.00 effective on year 1
and increases by 15% every year for 5 years, where
the value of money is 9%. What is the equivalent
present cost over the time horizon?

MLMPepito2020
 Uniform Gradient
b. Geometric Uniform Gradient
Example no.3:
Given: G= 15,000 r=15% i=9% n=5yrs
Solution:
1 r
a   1 an 
1 i P  G 
1  ( 0 . 15 )  1  i 1  a  
a 
1  ( 0 . 09 )  1  (1.055) 5 
P  15,000  
a  1 . 055  1  0 . 09 1  (1 . 055 )  
P  Php76,804.00
MLMPepito2020
Uniform Gradient
b. Geometric Uniform Gradient
Example no.4:
A graduating CE is going to make Php180,000/yr with
Granite Construction. A total of 10% of the CE salary
will be placed in the mutual fund of their choice. The
CE can count on a 3% salary increase with the
standard of living increases for the next 30 years of
employment. If the CE is aggressive and places their
retirement in a stock index fund that will average
12% over the course of their career, what can the CE
expect at retirement?

MLMPepito2020
 Uniform Gradient
b. Geometric Uniform Gradient
Example no.4:
Given: G= 180,000(0.10)=18,000 r=3%, i=12%, n=30yrs
Solution:
1 r
a   1 an 
1 i P  G 
1  ( 0 . 03 )  1  i 1  a  
a 
1  ( 0 . 12 )  1  (0.9196) 30 
P  18,000  
a  0 . 9196  1  0 . 12 1  ( 0 . 9196 )  
P  Php183,721.26
MLMPepito2020
Uniform Gradient
b. Geometric Uniform
Gradient
Example no.4, solution:

P  Php183,721.26
F  P (1  i ) n
F  183 ,721 .26 (1  0 .12 ) 30
F  Php 5,504 , 266 .85

MLMPepito2020
Uniform Gradient
Seatwork:
1.Find the cash present worth of all the cash disbursements
using gradient interest formulas if money is worth 10% per
annum. Annual cash disbursements increase by Php1,200.00
every year thereafter, until the end of the sixth year. The first
cash disbursement amounts to Php8,000.00.
2. Tuition costs are expected to inflate at the rate of 8% per
year. The first year’s tuition is due one year from now and will
be $10,000. To cover tuition cost for 4 years, a fund is to be
set up today in an account that will earn interest at the rate of
5% per year, compounded annually. How much must be
deposited into the fund today in order to pay the 4 years of
tuition expenses?

MLMPepito2020