ENGINEERING ECONOMY

CHAPTER 1
INTEREST AND MONEY-TIME RELATIONSHIPS

Money refers to any medium of exchange that is widely accepted

in the payments of goods or services and/or in settlement of debts.

Interest is the amount of money paid for the use of money called
capital for a certain period of time or the income produced by
money which has been loaned.

SIMPLE INTEREST
is the interest to be paid which is proportional to the length of time the principal is used.

I = P(i)n
F=P+I  F = P + P(i)n
F = P [1 + i(n)]

where: I = interest
P = Principal or present worth
F = Accumulated amount or future worth
i = rate of interest per interest period
n = number of interest periods

Types of Simple Interest

a. Ordinary Simple Interest (computed based on banker’s year)
1 banker’s year = 12 months
1 month = 30 days

b. Exact Simple Interest (computed based on exact number of days)

1 year = 365 days for ordinary year
= 366 days for leap year

Example 1:
Determine the interest on $ 700 for 8 months and 15 days if the rate of interest is 15%

Solution:
I = P(i)n
where n = 8(30) + 15 = 255 days

I = $ 700(0.15)(255/360)
I = $ 74.38

Lecture notes of Engr Rosalito Juda V. Eboa

 ENGINEERING ECONOMY

Example 2:
Determine the interest on $ 700 for the period from Jan 10 to Oct 28, 2008 if the rate of
interest is 15%.
Solution:
Jan 10 – 31 = 21 (excluding Jan 10) Since the given is an
February = 29 exact date so we are
March = 31 calculating the time
April = 30 based on exact
May = 31 number of days
June = 30
July = 31
August = 31
September = 30
October = 28 (including Oct 28)
292 days

I = P(i)n
I = $ 700 (0.15)(292/366)
I = $ 83.77

Example 3:
Determine the interest due on $ 10,000 loan which was made on April 01, 2008 and
repaid on September 01, 2012 with a rate of interest is 10% per year using
a. Ordinary Simple Interest
b. Exact Simple Interest

Solution:
a. Ordinary Simple Interest

I = P(i)n
I = $10,000(0.10)(4+5/12)
I = $ 4,416.67

b. Exact Simple Interest

I = P(i)n
I = $10,000(0.10)(4+153/365)
I = $ 4,419.18

Lecture notes of Engr Rosalito Juda V. Eboa

 ENGINEERING ECONOMY

Cash Flow Diagram

is a simple graphical representation of cash flows drawn on a time scale. It is used to
simplify problems having diverse receipts and disbursements

= receipt (cash inflow or positive cash flow)

= disbursement (cash outflow or negative cash inflow)

Example 4:
A loan of Php 1000 at simple interest of 10% will become Php 15,000 after 5 years.

1000 1500

5
0
0 1 2 3 4
1 2 3 4 5

1000
1500
Cash flow diagram Cash flow diagram
(Borrower’s Viewpoint) (Lender’s Viewpoint)

PROMISSORY NOTES
is a written promise of a person or business (as maker) to pay another person or business
(payee) within a specified period of time.

Types of Notes

a. Simple Interest Note

is a note where the value is stated on the note (face value) which corresponds to
the principal amount, the total amount to be repaid (maturity value of the note), and
the date to which the amount is due (maturity date)

I = P(i)n
where I = Interest
P = principal
n = no of years
i = interest rate

Lecture notes of Engr Rosalito Juda V. Eboa

 ENGINEERING ECONOMY

b. Bank Discount Note

is a note where the value is stated on the note corresponds to the maturing
amount to which the interest is being calculated and is deducted in advance. (The
amount received by the maker is proceeds)

D = A(d)n
where D = discount (advance interest)
P = principal
n = no of years
d = discount rate

DISCOUNT
is the difference between the present worth and the future worth

D=A–P
D = A(d)n
A = P [1 + i(n)]

d = 1 – 1/(1+i)

i = d/(1-d)

Example 5:
Mr Roberts was granted a loan of $ 50,000 by the cooperative bank with an interest rate
of 6% for 180 days on the principal collected in advance. The bank accepts a
promissory note for $ 50,000 non-interest for 180 days. Find the proceeds of the note if
it is discounted at once.

Solution:

I = P(i)n where n = 1 period (180

days)
I = $ 50,000(0.06)(1) D = A(d)n
I = $ 3,000 = $53,000(0.0566)(1)
D = $2,999.8
Solving for Future Amount
A=P+I Proceeds = $50,000 – 2,999.8
= $ 50,000 + 3,000 Proceeds = $47,000.2
A = $ 53,000

d = 1 – 1/(1+0.06)
d = 0.0566

Lecture notes of Engr Rosalito Juda V. Eboa

 ENGINEERING ECONOMY

Example 6:
On July 11, 2011, Engr J Villa received $ 60,000 from a credit cooperative and promised
to pay $ 68,000 on Dec 20, 2011. If the interest was decided in advance, what was the
discount rate?

Solution:

D=A–P
D = 68,000 – 60,000
D = $ 8,000

Solving for the discount rate, d

d = D/A(n)
d = 8000 / 68,000(192/360)
d = 0.2206 or 22.06%

Lecture notes of Engr Rosalito Juda V. Eboa

 ENGINEERING ECONOMY

Problem Set 1.1

1. John purchase a computer set from a merchant who asks Php 38,000 at the end 60
days (cash in 60 days). John wishes to pay it immediately and the merchant offers
to compute the cash price on the assumption that money is worth 8% simple
interest. What was the cash price?

2. Mr Jud borrowed money from the bank. He received from the bank Php 13,400 and
promised to pay the amount Php 15,500 at the end of 9 months. What was the
discount rate?

3. If Php 10,000 becomes Php 13,215 after 4 years when invested at a certain nominal
rate of interest compounded semi-annually, determine the effective rate of interest.

4. Joshua applied for a car loan in a local financing bank which charges a rate of
interest of 18%. Interest in this type of transaction is to be deducted from the loan at
the time the money is released. At the end of one year, the borrower will have to
pay the same amount what was stated in his application for the loan. What was the
actual rate of interest did the financing bank charge him?

5. Rosie borrowed from a bank under a promissory note that he signed in the amount
of Php 25,000 for a period of one year. He received only the amount of Php 21,915
after the bank collected the advance interest and an additional amount of Php 85.00
for notarial inspection fees. What was the rate of interest that the bank collected in
advance?

6. If you borrow money from your friend with simple interest of 12%, find the present
value of Php 20,000 which is due at the end of 10 months.

7. Find the amount due at the end of 15 months whose present value is Php 2,000 at
5% simple discount rate.

8. A loan was made 3 years and 4 months ago at 6% simple interest. The principal
amount of the loan has just been repaid along with Php 800 interest. Compute the
principal amount of the original loan.

9. A bank deposit of Php 6,000 was made one year ago in one of the local banks which
pays monthly interest. The bank account accumulates now Php 6,392.60. Compute
the effective annual interest rate.

10. Find the discount if Php 2,000 is discounted for 6 months at 8% simple discount.

11. A bank charges 12% simple interest on a Php 2,500 loan. How much will be repaid
if the loan is paid back on lump sum after three years?

Lecture notes of Engr Rosalito Juda V. Eboa

 ENGINEERING ECONOMY

12. What simple interest rate is equivalent to the simple discount rate of 6% discounting
an amount of Php 1,000 due at the end of three months?
COMPOUND INTEREST
is the interest earned by the principal which is added to the principal to earned an interest in
the succeeding period.

From F = P + I or A = P + P(i)(n)
F3
End of first year
I3
F2 F1 = P + P(i)
F1 = P[1 + i]
F1 i2

i1 End of second year

P
F2 = F1 + F1 (i)
F2 = F1 [1 + i]
F2 = P[1+i]2
0 1 2 3
In General:
Fn = P[1+i]n

TYPES OF RATE OF INTEREST

a. Nominal Rate of Interest
specifies the rate of interest and a number of interest periods in one year

i = r/m where
i = rate of interest per interest period
r = nominal rate of interest
m = mode of compounding

b. Effective Rate of Interest

is the actual or exact rate of interest on the principal during one year

ie = [1 + r/m]m – 1

Example 7:
If P 1.00 is invested at a nominal rate of 15% compounded quarterly, what is the
effective rate of interest

Solution:
ie = [1 + r/m]m – 1

ie = [1 + 0.15/4]4 – 1

ie = 15.86%

Lecture notes of Engr Rosalito Juda V. Eboa

 ENGINEERING ECONOMY

Example 8:
In how many years is required for P 8,000 to increase by P 12,000 if the interest is at 8%
compounded semi-annually

Solution:
F = P[1 + r/m]nm

20,000 = 8,000 [1 + 0.08/2]2n

n = 11.68 years, say 12 years

Example 9:
A Mechanical Engineer wished to accumulate a total of P 100,000 in a savings account
at the end of 15 years. If the bank pays only 4% compounded quarterly, what should be
the initial deposit?

Solution:
F = P[1 + r/m]nm

100,000 = P[1 + 0.04/4](15)4

P = Php 55,044.96

Example 10:
By the condition of a will, the sum of P 25,000 is left to a girl to be held in trust by her
guardian until it amounts to P 50,000. When will the girl receive the money if the fund is
invested at 8% compounded quarterly?

Solution:
F = P[1 + r/m]nm

50,000 = 25,000[1 + 0.08/4]4n

n = 8.75 years, say 9 years

Lecture notes of Engr Rosalito Juda V. Eboa

 ENGINEERING ECONOMY

EQUATION VALUE
is obtained by setting the sum of the values of a certain comparison / data to a single date
point (known as the time reference).

Example 11:
A man bought a lot worth Php 1,000,000 if paid in cash. On an instalment basis, he paid
a downpayment of Php 200,000; Php 300,000 at the end of one year; Php 400,000 at
the end of three years and a final payment at the end of five years. What was the final
payment if the interest was 20%?

Solution:

800,000 Ref point

1 2 3 4 5

0
300.000

400.000
D

Using the ref point (today), the equation value is:

300,000 D = Php 792,560.00

800,000 =
¿¿

CONTINUOUS COMPOUNDING AND DISCRETE PAYMENTS

In discrete compounding, the interest is compounded at the end of each finite – length
period such as month, quarter or a year. It is assumed that cash payment is done once a
year but the compounding is continuous throughout the year.
r (n)
F = P e

Example 12:
Compare the accumulated amounts after 5 years of Php 1,000 invested at a rate of 10%
per year compounded (a) annually, (b) semi-annually, (c) quarterly, (d) monthly, (e)
daily, and (f) continuously.

Solution:

Using the formula: F = P¿

a) F = 1000 ¿

Lecture notes of Engr Rosalito Juda V. Eboa

 ENGINEERING ECONOMY

( )
10
0.10
b) F = 1000 1+ = 1,628.89
2

c) F = 1000 ( 1 +
4 )
20
0.10
= 1,638.62

d) F = 1000 ( 1 +
12 )
60
0.10
= 1,645.31

e) F = 1000 ( 1 +
365 )
1825
0.10
= 1,648.61

0.10 ¿¿
f) F = 1000 ( e )

Example 13:
A nominal interest of 3% compounded continuously is given on the account. What is the
accumulated amount on Php 10,000 after 10 years?

Solution:
F = P e r (n)
F = 10,000 e 0.03(10)
F = Php 13,489.59

Lecture notes of Engr Rosalito Juda V. Eboa

 ENGINEERING ECONOMY

Problem Set 1.2

1. How long will it take money to double itself if invested at 5% compounded annually?

2. John borrowed Php 150,000 from a bank at 15% compounded semi-annually. What is the
equivalent effective rate of interest?

3. A company invests Php 10,000 today to be repaid in 8 years in one lump sum at 8%
compounded semi-annually. How much profit in present day is realized over 8 years?

4. The sum of Php 52,000 was deposited in a fund earning an interest rate 0f 8% per annum
compounded quarterly. What was the amount of fund at the end of 4 years?

5. You had Php 15,000 invested in your personal bank account and is currently earning at 12%
interest compounded annually. Determine how many years your savings will be doubled.

6. Accumulates Php 45,000 for 9 years at 6% compounded quarterly. What was the
compound interest earned?

7. If $25,000 is invested at 8% compounded quarterly, how many years will it take for this
amount to accumulate $45,000?

8. Five years ago, you paid Php3,400,000 for a house. If you sold it today at Php5,000,000,
what would be your annual appreciation?

9. Ten years ago, the value of money is Php125,000 and now it is worth Php183,000. What
was the interest rate charge per year compounded annually?

10. Php200,000 was deposited for a period of 5 years and 9 months and bears an interest of
Php 95,698.35. What was the rate of interest if it is compounded quarterly?

11. Find the nominal rate which if compounded quarterly is equivalent to 6.5% compounded
semi-annually.

12. JR and JJ borrowed P5,000 from a lending company for 5 years at 12%. At the end of 5
years, they renew the loan for the amount due plus Php 4000 more for 3 years at 12%.
What was the lump sum amount due?

13. John and Rosie borrowed money of Php20,000 in 2018, Php 15,000 in 2019 and Php
23,000 in 2020. How much are they going to pay in 2022 if the interest charge is 6%
compounded annually?

14. Judie wants to have Php 500,000 four years from now? What amount should be invested
now if it is to earned 6% compounded quarterly for the first two years and 8% compounded
semi-annually during the next two years?

15. A certain credit company charges 1.5% interest per month compounded continuously on the
unpaid balance purchases made on his credit card. Compute the effective rate of interest.

Lecture notes of Engr Rosalito Juda V. Eboa

 ENGINEERING ECONOMY

Lecture notes of Engr Rosalito Juda V. Eboa