ENGINEERING ECONOMY

❑ Is a discipline concerned with the economic aspects of

engineering and involves the systematic evaluation of the
costs and benefits of proposed engineering or business
projects and ventures
❑ Involves making decision by balancing revenues and
expenses that occur now and in the future
❑ Deals with the concepts and techniques useful in the
evaluation of the worth over costs of the product, projects,
and systems that engineers design.
- 4 PROCESS OF STUDYING ENGINEERING ECONOMY
- 1. The definition step
- 2. The conversion step
- 3. The evaluation step
- 4. The decision step
 INTEREST & DISCOUNT
 Money – is any article or substance used as a medium of exchange,
means of payment or measure of wealth. However, when money is
invested in business or deposited in a bank, everyone is expecting of an
income called the interest.
 Like taxes, interest has existed from earliest recorded human history.
Records reveal its existence in Babylon in 2000 B.C. In the earliest
instances interest was paid in money for the use of grain or other
commodities that were borrowed; it was also paid in the form of grain
or other goods. Many of the existing interest practices stem from early
customs in the borrowing & repayment of grain & other crops.
 Interest – is the amount of money paid for the use of borrowed capital
(borrower) or the income produced by the money which was lent
(lender).
 SIMPLE INTEREST
When the total interest earned or charged is directly proportional to the
initial amount of the loan (principal), the interest rate, and the number of
interest periods for which the principal is committed, the interest rate are
said to be simple; or if the interest to be paid is directly proportional to
the length of time the amount or principal is borrowed.
The formula for simple interest is :
I = Pin
Where: I = total interest earned by the principal
 P = present worth or principal
 i = rate of interest per period
 n = no. of interest periods

The total amount F to be repaid is equal to the sum of the principal and the
total interest & is given by the formula:
 F=P+I where: F = future amt. or the accumulated
 = P (1 + in) amt.
 ORDINARY and EXACT SIMPLE INTEREST
Ordinary simple interest is computed on the basis of one banker’s year, which is
1 banker’s year = 360 days/year
 = 30 days/month
 = 12 months/year
Exact simple interest is based on the exact number of days
= 365 days/year
= 366 days/leap year
Note:
A year w/c is exactly divisible by four (4) is a leap year except century years
such as 1900, 2000, etc.

If d is the number of days in the interest period, then:

Ordinary simple interest I = Pi (d/360)

Exact simple Interest I = Pi (d/365) for ordinary year

I = Pi (d/366) for leap year
Sample Problem:
1. Determine the ordinary simple interest on P10,000 for 9 months & 10
days if the rate of interest is 12%.
Sol’n.
Based on a banker’s year,
9 months and 10 days = 9(30) + 10 = 280 days
Ordinary simple interest (I) = Pi (d/360)
= (P10,000)(.12)(280/360)
= P933.33
2. Determine the ordinary & exact simple interest on P5,000 for the period from
January 15 to June 20, 1993, if the rate of simple interest is 14%
Sol’n.
Determine first the number of days in the given period
Jan 15 – 31 = 16
Feb = 28 Jan 15 – June 15 = 5 * (30) = 150 days
Mar = 31 June 16 – June 20 = 5 days
Apr = 30
May = 31
Jun 1 – 20 = 20
Total = 156 days

Ordinary simple interest (I) = Pi (d/360)

= (P5,000)(.14)(155/360) = P301.39

Exact simple interest (I) = Pi (d/365)

= (P5,000)/(.14)(156/365) = P299.18
3.What will be the future worth of money after 14 months, if a sum of
P10,000 is invested today at a simple interest rate of 12% per year?
Sol’n:
P = P10,000 i = .12 n = 14/12

F = P (1 + in)
= P10,000 [ 1 + (.12)(14/12)]
F = P11,400
P = 1000 n = Jan. 9, 2018 – Aug. 24, 2018
i = 10% per year Io ; Ie = ?
Exercises:
1. A man deposited P5000 in a bank at a rate of 10% per annum for 10
months and 25 days. Find the ordinary simple interest and the
accumulated amount.
Sol’n.
n = 10(30) + 25 = 325 days F = P+I
I = Pin = 5000 + 451.39
= (5000)(.10)(325/360) F = P5451.39
I = P451. 3888889

2. If you borrow money from your friend at 12% simple interest, determine
the present worth of P20,000 w/c is due at the end of 9 months.
Sol’n.
F = P (1 + in)
20,000 = P [1 + (.12)(9/12)]
20,000 = P (1.09)
P = P 18, 348.62385
3. A bank charges 12% simple interest on P300 loan. How much will be
repaid if the loan is paid back in one lump sum after three years?
Sol’n.
F = P (1 + in)
= 300 [1 + (.12)(3)]
F = P408

4. A bank loan of P2,000 was made at 8% simple interest. How long would
it take in years for the amount of the loan and interest to equal P3,280?
Sol’n.
F = P (1 + in)
3280 = 2000 [1 + (.08)n]
3280 = 2000 + 160n
3280 – 2000 = 160 n
n = 1280/160
n = 8 years
5. A loan was made 3 years and 4 months ago at 6% simple interest.
The principal of the loan has just been repaid along with P800 of
interest. Compute the principal amount of the original loan.
Sol’n.
n = 3 + (4/12) = 3.33
I = P800
i = .06
P= ?

I = P in
800 = P (.06)(3.33)
P = P4000
6. Find the ordinary and exact simple interest on the
following:
a. P 9,000.00 for 120 days at 5%
b. P 12,000.00 for 100 days at 6%
c. P 17,500.00 from June 10, 1980 to November 7, 1980 at
5%.
d. P 20,000.00 from October 18, 1981 to February 6, 1982 at
5 ¼%
 ASSIGNMENT
1. To the purchaser of a house, which is the better offer: P
40,000.00 down and P 60,000.00 in 6 months or P 60,000
down and P 40,000.00 in a year? Assume money is worth
6% and compare on the date of purchase the value of each
offer.
2. Mr. A borrows P 12,000.00 with interest at 6% for two years
from Mr. B. What should Mr. B accept in settlement 15
months after the money was borrowed if money is then
worth 5% to him?
3. What is the annual rate of interest if P 265.00 is earned in
four months on an investment of P 15,000.00?
4. A loan of P 2,000.00 is made for a period of 13 months, from
January 1 to January 31the following year, at a simple
interest rate of 20%. What future amount is due at the end
of the loan period?
5. If you borrow from your friend with simple interest of 12%,
find the present worth of P 20,000.00,which is due at the end
of nine months.
6. Determine the exact simple interest on P 5,000.00 for the
period from Jan. 15 to Nov. 28, 1992 if the rate of interest is
22%.
 DISCOUNT
Discount on a negotiable paper is the difference bet. the
present worth (the amount received for the paper in cash)
& the worth of the paper at some time in the future (the
face value of the paper or principal).
Discount (D) = Future worth – Present worth or

The present value P of a sum F at some later date may be

considered as the discounted value of F.
Thus,
D = (F – P) is the simple discount on F at an interest
rate. Also called the true discount on F.
P=F-D
Discount is interest paid in advance.
SIMPLE DISCOUNT at a DISCOUNT RATE ( also called BANK DISCOUNT and
INTEREST in ADVANCE)
The rate of discount is the ratio of the discount given in a unit of
time (one year) to the amount on w/c the discount is given.
D = Fdt P = F – D = F – Fdt = F (1 –dt)
Where:
D = simple discount
F = Future amount or amount of loan
d = discount rate
t = period of loan
Rate of discount is the discount on one unit of principal for one unit of
time.
d = 1 – (1+i)-1 = D/F
= 1 - __1___
(1 +i)
Where: d = rate of discount for the period involved
i = rate of interest for the same period
 SAMPLE PROBLEMS
1. A man borrowed P5000 from a bank & agreed to pay the loan @ the end
of 9 months. The bank discounted the loan & gave him P4,000 in cash. (a)
What was the rate of discount? (b) What was the rate of interest? (c)
What was the rate of interest for one year?
Sol’n.
F (principal) = P5000, P = P4000, n = 9/12 d=? i=?

(a) d = D/F (discount/principal) (c) i = I/Pn

= 1000 = 1000
5000 (4000)(9/12)
d = .20 or 20% = .3333 or 33.33%

(b) i = D/P (discount/present worth) OR i = d/(1-d)

= 1000/4000 = .20/(1-.20)
= .25 or 25% = .25 or 25%
2.In buying a computer disk, the buyer was offered the options of
paying P250 cash at the end of 30 days or P270 @ the end of 120
days. At what rate is the buyer paying simple interest if he agree to
pay @ the end of 120 days?
Sol’n.
0_________30_____(90 days)__________120
P250 P270

Interest (D) = 270 – 250

= P20

I = Pin
20 = 250 (i)(90/360)
i = .32 or 32%
3. A man borrowed P20,000 fr. a local commercial bank w/c has a simple
interest of 16% but the interest is to be deducted from the loan at the
time that the money was borrowed, & the loan is payable @ the end of 1
yr. How much is the actual rate of interest?
Sol’n.

Interest (D) = .16 (20,000)

= P3,200
P=F–D
= P20,000 – P3,200
= P16,800

i = D/P OR i = d/(1-d) = 3,200/16,800 = .19 or

19% = .16/(1 - .16)
= .19 or 19%
 COMPOUND INTEREST

It is a method of paying interest where the interest earned on the previous

period is added to the principal for the succeeding period and earn
interest too. Hence, in other words it is interest on top of interest.
FORMULAS:
F = P(1 + i)n
The quantity (1+i)n is commonly called the “single payment compound
amount factor” & is designated by the functional symbol F/P,i%,n. Thus,
F = P (F/P,i%,n)
The symbol F/P,i%,n is read as “F given P @ i percent in n interest periods.”

P = F(1+i)-n
The quantity (1+i)-n is commonly called the “single payment present worth
factor” & is designated by the functional symbol P/F,i%,n. Thus,
P = F (P/F,i%,n)
The symbol P/F,i%,n is read as “P given F @ i percent in n interest periods.”
1.Nominal rate of interest (r) – specifies the rate of interest & the
number of interest periods in one year
i = r/m r = im
where: i = rate of interest per interest period
r = nominal interest rate
m = no. of compounding periods per year

Methods of compounding Value of m

Annually 1
Semi-annually 2
Quarterly (every 3 mos.) 4
Bi-monthly (every 2 mos.) 6
Monthly 12
Weekly 52
Daily 365
2. Effective rate of interest – is the actual or exact interest on the
principal during one year.
Effective rate = (1 + i)m-1
= (1 + r/m)m-1
 Interest
Nominal No. of compounding
Interest rate (r) per year (m)
rate/compounding ieffective ( 1 + r/m)n - 1
period (r/m)

15% Annually 1 0.15/1 = 0.15/yr. (1 + 0.15/1)^1-1 0.15

Semi-
15% 2 0.15/2 = 0.075/s.a.p. (1 + 0.15/2)^2-1 0.155625
annually

0.15/4 =
15% Quarterly 4 (1 + 0.15/4)^4-1 0.158650415
0.0375/quarter

0.15/12 =
15% Monthly 12 (1 + 0.15/12)^12-1 0.160754518
0.0125/month

0.15/52 =
15% Weekly 52 (1 + 0.15/52)^52-1 0.161583394
0.00288/week

0.15/365 =
15% Daily 365 (1 + 0.15/365)^365-1 0.161798443
0.00041/day
 No. of Interest
Nominal Int.
compounding rate/Compounding ieff = (1+r/m)n -1
rate (r)
per yr. (m) period (r/m)

12% 1 (annually) .12/1 = .12/y (1 + 0.12/1)1 – 1 = 0.12

12% 2 (semi-annually) .12/2 = 0.06/s.a.p. (1 + 0.12/2)2 – 1 = 0.1236

12% 4 (quarterly) .12/4 = 0.03/q (1 + 0.12/4)4 – 1 = 0.1255

12% 12 (monthly) .12/12 = 0.01/m (1 + 0.12/12)12 – 1 = 0.1268

12% 52 (weekly) .12/52 = 0.0023/w (1 + 0.12/52)52 – 1 = 0.1273

12%
365 (daily) .12/365 = 0.0033/d (1 + 0.12/365)365 – 1 = 0.1275
 COMPARISON BETWEEN SIMPE INTEREST AND
COMPOUND INTEREST

P = 1,000 n = 3 yrs i = 10%/yr F=?

SIMPLE INT. COMPOUND INT.

F = P (1+in) F = P (1+i)n
= 1000 {1+(0.10*3)} = 1000 (1.1)3
F = P 1300 F = P 1331
COMPARISON BETWEEN SIMPLE INTEREST AND COMPOUND INTEREST
SIMPLE INTEREST
AMT OWED PAYMENT
Y INT EOY (.10) AO EOY
BOY EOY

1000(0.10)
1 1000 - 1100
= 100

2 100 - 1200

3 100 1300 -

COMPOUND INTEREST
AMT OWED PAYMENT
Y BOY
INT EOY (.10)
EOY
AO EOY

1000 (0.10)
1 1000 - 1100
= 100
1100(0.10) =
2 1100 - 1210
110
1210(0.10) =
3 1210 1331 0
121
Sample problems:
1. Find the amount at the end two years & seven months if
P1000 is invested @ 8% compounded quarterly using simple
interest for anytime less than a year interest periods.
Sol’n.
For compound interest: i = 8%/4 = 2% n = 2(4) = 8
For simple interest: i = 8% n = 7/12

F(c) = P (1+i)n = 1000(1+.02)8 = P1171.659381

F(s) = P(1+in) = P1171.659381 [1 + (7/12)(.08)] =
P1226.336819
2. How long will it take for money to double itself if invested at
5% compounded annually?
Sol’n.
Let x = present amt.
2x = future amt.
F = P (1+i)n
2x = x (1+.05)n
log2 = n log 1.05
n = log2
log 1.05

n = 14.20669908 = 14yrs.
3. John borrowed P50,000 fr. the bank at 25% compounded semi-annually.
What is the equivalent effective rate of interest?
Sol’n:
Effective rate of int. = (1 + i)m-1
= (1 + r/m)m-1
= (1 + .25/2)2-1
= .265625 = 26.56%

4. Compute the equivalent rate of 6% compounded semi-annually to a

rate compounded quarterly.
Sol’n:
( 1 + 0.06/2)2 = ( 1 + r/4)4
(1.0609)1/4 = [( 1 + r/4)4]1/4
1.014889157 = ( 1 + r/4)
1.014889157 – 1 = r/4
(0.014889157)4 = r
= .059556626 = 5.96%
1. How long in years will it take money to quadruple if it
earns 7% compounded semi-annually?
Sol’n.
Let x = present amt. 4x=future amt. i=.07/2=.035 n=?
F = P (1 +i)n
4x = x (1+0.035)2n
4 = (1.035)2n
Ln4 = 2n ln1.035
n = ln 4/ 2ln1.035
n = 20.14879168 yrs.
2. The Phil. Society of Mechanical Engineers is planning to put up its own building.
Two proposals being considered are:
A. The construction of the building now, to cost P400,000.00
B. The construction of a smaller building now, to cost P300,000.00 at the end of 5
years, an extension to be added to cost P200,000.00
Which proposal is more economical, if interest rate is 20%, depreciation to be neglected
and by how much?
Sol’n.
For Proposal A:Present Worth = P 400,000.00

For Proposal B: Present Worth:

= P 300,000 + 200,000/ (1+.20)5
= P 300,000 + P80, 375.5144
= P 380, 375.5144

P 400,000 – P 380, 375.5144

= P19, 624.4856
Therefore B is more economical
3.A man wants to receive P800.00 immediately and pay it back in one
year. The bank charges a simple discount of 6% payable at once. How
much must be borrowed? What is the rate of interest?
Sol’n.
d = .06
d (rate of disc.) = D/F
d= (F-P)/F
.06 = (F – 800)
F
F = P851.06

i= d or i = D/P
1-d
= 0.06 = F – P = 851.06 - 800
1-0.06 P 800
i = 0.0638 = 6.38% = 6.38%
4. If the single payment amount factor for a period of five years is 1.33822.
What is the nearest value of the interest rate?
Sol’n.
n=5
(1 + i)n = 1.33822
(1 + i)5 = 1.33822
1 + i = 1.059994
i = .059994 = 6%

5. A man borrowed P 100,000.00 at an interest rate of 12% per annum,

compounded quarterly. What is the effective rate?
Sol’n.
Effective rate = (1 + i)m-1
= (1 + r/m)m-1
= [ 1 + (.12/4)4 – 1
Effective rate = 12.55%
1.When will an amount be tripled with an interest of 11.56%?
Sol’n.
F = P (1 + i)n
3P = P (1 + .1156)n
3 = (1.1156)n
Ln3 = n ln 1.1156
n = ln3/ln1.1156
n = 10 yrs.
2. Suppose a businessman is considering the purchase of a business
machine that is expected to be obsolete in five years. The machine is
worth P110,000.00 The prevailing rate of interest is 15%. Suppose he
made an estimate of his gross yearly income as follows:
Year Income
1 P 20,000
2 P 25,000
3 P35,000
4 P30,000
5 P28,000
Total = P138,000
Is the business profitable?
Sol’n:
PTotal = P1 + P2 + P3 + P4 + P5
= [20,000/(1.15)1] + [25,000/(1.15)2] + [35,000/(1.15)3] +
[30,000/(1.15)4] + [28,000/(1.15)5]
= P 93, 381.51013
Therefore, the business is not profitable since the machine cost more.
3. What is the present worth of two P100.00 payments at the end of the
third year and fourth year? The annual interest rate is 8%?
Sol’n.
F = 100 n = 3, 4 i = .08
PTotal = P3 + P4
= [ 100/(1.08)3] + [ 100/(1.08)4]
= P 79.3832241 + P 73.50298528
PTotal = P 152.8862094

4. Compute the discount if P2,000.00 is discounted for 6 months at 8%

simple interest.
Sol’n.
F = P ( 1 + in) D = F-P
2000 = P [ 1 + (.008)(6/12)] = 2000 – 1923.076923
P = P1923.076923 = 76.92307692
5. If the single payment present worth factor for a period of 8 years is equal
to 0.58201, compute the nearest value of the rate of interest for that period.
Sol’n.
( 1 + I )-n = .58201
___1___ = .58201
(1 + i)8

( 1 + i )8 = 1.7181835
1+i = 1.07
i = 0.07
i = 7%
6. A rich man put up a trust fund in the bank with instructions to give to his
son the earnings of P 400,000.00 at the end of every four (4) years and to
continue until the twentieth (20th) year of the deposit when the son could get
the P 400,000.00 earning and the principal. What is the amount of money
placed in the trust fund if guaranteed interest is 16% per year?
 CONTINUOUS COMPOUNDING
In continuous compounding, it is assumed that cash payments occur
once per year, but the compounding is continuous throughout the year.
FORMULAS:
Future Worth: F = Per n
Present Worth: P = Fe-r n = F/er n
Compound amount factor: er n = comp. amt. factor
Present worth factor: 1/er n = present worth factor
where: r = rate of continuous comp. int.
n = no. of periods
Effective annual interest:
ie = er – 1 (effective annual interest rate)
where: ie = effective annual int. rate
r = nominal rate of interest comp. continuously
 Sample problem:
.
1. Find the accumulated amount of P5000 when deposited in a
bank at a rate of 12% compounded continuously for 5 yrs.
F = Pern
= (5000)e.12(5) = P9,110.60

2. Find the effective rate of interest equivalent to 12%

compounded continuously.
ie = er – 1
= e.12 – 1
= .1275 or 12.75%

3. Compute the effective annual int. rate w/c is equivalent to

5% nominal annual interest compounded continuously.
ie = er – 1
= e.05 – 1 = (2.71828).05 – 1 = 0.0513 = 5.13%
 SEATWORK

1. Mr. A signs a note promising to pay Mr. B P30,000.00 in 6

years with interest at 5% compounded quarterly. Four
years later Mr. B sells the note to Mr. C. How much did Mr.
C pay if money is then worth 4% compounded semi-
annually?

2. A debt of P25,000.00 overdue for 2 years and another of

P75,000.00 due in 3 years are to be discharged today by a
single payment. Find the payment if money is worth 5%
compounded semi-annually.

3. A lot is sold for P50,000.00 cash and P25,000.00 a year for

the next 4 years. If money is worth 6% effective, find the
cash value of the lot.
4. A manufacturing firm is contemplating retiring an existing
machine at the end of 1982. the new machine to replace
the existing one will have an estimated cost of
P100,000.00. this expense will be partially defrayed by
sale of the old machine as scrap for P7,500.00. to
accumulate the balance of the required capital, the firm
will deposit the following sums in an account earning
interest at 5% compounded quarterly:
P15,000.00 at the end of 1979
P15,000.00 at the end of 1980
P20,000.00 at the end of 1981
What cash disbursement will be necessary at the end of
1982 to purchase the new machine?
 SEATWORK
1. What is the annual rate of interest if P265 is earned in
four months on an investment of P15,000?
2. A loan of P2,000 is made for a period of 13 months, from
January 1 to January 31 the following year, at a simple
interest rate of 20%. What future amount is due at the
end of the loan period?
3. If you borrow money from your friend with simple interest
of 12%, find the present worth of P20,000, which is due at
the end of nine months.
4. Determine the exact simple interest on P5,000 for the
period from Jan .15 to Nov. 28, 1992, if the rate of
interest is 22%.
5. A man wishes his son to receive P200,000 ten years from
now. What amount should he invest if it will earn interest
of 10% compounded annually during the first 5 years and
12% compounded quarterly during the next 5 years.
6. By the condition of a will, the sum of P25,000 is left to a girl
to be held in trust by her guardian until it amounts to
P45,000. when will the girl receive the money if the fund is
invested at 8% compounded quarterly?
7. At a certain interest rate compounded semiannually, P5,000
will amount to P20,000 after 10 years. What is the amount
at the end of 15 years?
8. Jones Corporation borrowed P9,000 from Brown Corporation
on Jan 1, 1978 and P12,000 on Jan. 1, 1980. Jones
Corporation made a partial payment of P7,000 on Jan. 1,
1981. it was agreed that the balance of the loan will would
be amortized by two payments one on Jan. 1, 1982 and the
other on Jan 1, 1983, the second being 50% larger than the
first. If the interest rate is 12%, what is the amount of each
payment?
9. A woman borrowed P3,000 to be paid after 1 ½ years with
interest at 12% compounded semi-annually and P5,000 to
be paid after 3 years at 12% compounded monthly. What
single payment must she pay after 3 ½ years at an interest
rate of 16% compounded quarterly to settle the two
obligations?
10. Mr. J. dela Cruz borrowed money from a bank. He
received from the bank P1,342 and promise to repay P
1,500 at the end of 9 months. Determine the simple
interest rate and the corresponding discount rate or often
referred to as the “Banker’s discount.”
11. A man deposits P50,000 in a bank account at 6%
compounded monthly for 5 years. If the inflation rate of
6.5% per year continues for this period, will this effectively
protect the purchasing power of the original principal?