Republic of the Philippines

NUEVA VIZCAYA STATE UNIVERSITY

Bambang, Nueva Vizcaya
INSTRUCTIONAL MODULE
IM No.3:ENG’G04-1S-2021-2022

College : COLLEGE OF ENGINEERING

Campus: BAMBANG CAMPUS

DEGREE PROGRAM Bachelor of COURSE NO. ENG’G 04

Science in
Mechanical
Engineering
SPECIALIZATION Mechanical COURSE TITLE Engineering Economics
YEAR LEVEL 3rd Year TIME FRAME 9 hrs WK NO. 6 - 8 IM NO. 3

I. UNIT TITLE/CHAPTER TITLE:

CHAPTER 3. ECONOMIC STUDY METHODS

II. LESSON TITLE:

1. The Minimum Attractive Rate of Return

2. Basic Economy Study Methods
2.1. Present Worth
2.2. Future Worth
2.3. Annual Worth
2.4. Internal Rate of Return
3.2. External Rate of Return
3. Other Methods
3.1. Discounted Payback Period
3.2. Benefit/Cost Ratio
3.3. Equivalent Uniform Annual Cost

III. LESSON OVERVIEW

This module gives an overview and discussion regarding the concepts behind interest and time value
of money, cash flows and concepts of equivalence. Moreover, the students will engage to construct cash
flow diagrams and make calculations regarding interest and cash equivalence.

IV. DESIRED LEARNING OUTCOMES

At the end of the lesson, the students should be able to:
1. provide understanding of the return capital in the form of interest.
2.illustrate how basic time value calculations are made relating to the cost of capital in engineering
economic studies.

V. LESSON CONTENT

ECONOMIC STUDY METHODS

Engineering or business projects require huge capital investments. Economy studies are
necessary to be conducted to establish whether a proposed capital investment and its associated
expenditures can be recovered over time in addition to a return on the capital that is attractive in view of
risks involved and opportunity costs of the limited funds. The concepts of interest and money-time
relationships are quite useful in arriving at the investment decision. Since different projects involve
different patterns of capital investment, revenue or savings cash flows and expenditure or disbursement
cash flows, no single method is perfect for making economy studies of all types. The following are some
of the basic methods in making economic studies.

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1. THE MINIMUM ATTRACTIVE RATE

OF RETURN (MARR)
MAAR is a reasonable rate of
return (percent) established for
evaluating and selecting alternatives.
An investment is justified economically
if it is expected to return at least the
MARR. It is also known as hurdle rate,
benchmark rate or cut – off rate.

MARR Characteristics:
1. MARR is established by the financial
managers of the firm
2. MARR is fundamentally connected to
the cost of capital
3. Both types of capital financing are
used to determine the weighted
average cost of capital (WACC) and the
MARR.
4. MARR usually considers the risk
inherent to a project.

2. BASIC ECONOMIC METHODS

2.1. Present Worth (PW) Method

This pattern for economic studies is based on the concept of present worth. If the present
worth of the net cash flows is equal to or greater than zero the project is justified economically.
The present worth method is flexible and can be used for any type of economic study. It is used
extensively in making economic studies in the public works field, where long lived structures are
involved.

2.2. Future Worth (FW) Method

The future worth method for economy studies is exactly comparable to the present worth
method except that all cash inflows and outflows are compounded forward to a reference point in
time called the future. If the future worth of the net cash flows is equal to or greater than zero, the
project is justified economically.

2.3. Annual Worth (AW) Method

In this method, interest on the original investment, sometimes called minimum required
profit is included as a cost. If the excess of annual cash inflows over annual cash outflows is not
less than zero, the proposed investment is justified – is valid. This method is covered by the same
limitations as the rate of return pattern a single initial investment of capital and uniform revenue
and cost throughout the life of the investment.

2.4. Internal Rate of Return (IRR)

The internal rate of return is defined as the internal rate paid on the unpaid balance of a
loan such that the payment schedule makes the unpaid loan balance equal to zero when the final
payment is made. It is also known as the interest rate earned on the uncovered investment such
that the payment schedule makes the uncovered investment equal to zero at the end of the life of
the investment.
The other term for IRR is rate of return (ROR), which is a measure of the effectiveness
of an investment of capital speaks of financial efficiency. When this method is used, it is necessary
to decide whether the computed rate of return is sufficient to justify the investment. The advantage
of this method is that it is easily understood by management and investors. The applications of
the rate of return method is controlled by the following conditions. A single investment of capital
at the beginning of the first year (t = 0) of the project life and identical revenue and cost data for

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each year. The capital invested is the total amount of capital investment required to finance the
project whether equity or borrowed.
Example: savings account earning can be reinvested in the same account.

The rate of return (percent) on the capital invested is given by the formula:

𝒏𝒆𝒕 𝒂𝒏𝒏𝒖𝒂𝒍 𝒑𝒓𝒐𝒇𝒊𝒕

ROR =
𝒄𝒂𝒑𝒊𝒕𝒂𝒍 𝒊𝒏𝒗𝒆𝒔𝒕𝒆𝒅

To apply rate of return analysis correctly, we need to classify an investment into either a
simple or non-simple investment.

A simple investment is defined as one in which the initial cash flows are negative and
only one sign change in the net cash flow occurs. The solving rate of return (i* %) is the rate of
return internal to the project; so the decision rule is:
▪ If IRR > MARR, accept the project
▪ If IRR = MARR, remain indifferent
▪ If IRR < MARR, reject the project

A non-simple investment is one for which more than one sign change in the cash
flow series occurs. Because the possibility of having multiple rates of return, it is recommended
the IRR analysis be abandoned and either the net positive value (NPV) or annual equivalence
(AE) analysis be used to make an accept/reject decision.

2.5. External Rate of Return (ERR)

The ERR is used when revenue cannot be reinvested back into the project The method
allows for an external reinvestment internal rate ii% or ɛ% to be considered, where ii or ɛ% is the
rate that cash flows generated by the project can be reinvested. It is where you put the cash that
is generated.
Example: Buying a rare painting as an investment and then selling it. You must buy something
else with the profits; earnings cannot be reinvested in the same painting.

Method:
a. Net cash outflows are discounted to time zero and ii or ɛ% (i.e. find PV of outflows).
b. Net cash inflows compounded to N (end of the cash flow diagram timeline).
c. ERR is the interest rate that establishes equivalence between these two quantities. Use
absolute value of the PW.

3. OTHER METHODS

3.1. Discounted Payback Period

The payback period is commonly defined as the length of time required to recover the first
cost of an investment from the net cash flow produced by that investment for an interest rate of
zero. The alternative with the shortest payback period is adopted. To use this method, the
payback period of each alternative is computed as:

𝒊𝒏𝒗𝒆𝒔𝒕𝒎𝒆𝒏𝒕−𝒔𝒂𝒍𝒗𝒂𝒈𝒆 𝒗𝒂𝒍𝒖𝒆
Payout period (years) =
𝒏𝒆𝒕 𝒂𝒏𝒏𝒖𝒂𝒍 𝒄𝒂𝒔𝒉 𝒇𝒍𝒐𝒘

3.2. Benefit/Cost Ratio

The benefit cost ratio or benefit-to-cost ratio compares the present value of all benefits
with that of the cost and investments of a project or investment. These benefits and costs are
treated as monetary cash flows or their equivalents, e.g. for non-monetary benefits or company-
internal costs. The benefit/cost ratio is calculated as:

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𝑷𝒓𝒆𝒔𝒆𝒏𝒕 𝒘𝒐𝒓𝒕𝒉 𝒐𝒇 𝒃𝒆𝒏𝒆𝒇𝒊𝒕𝒔

B/C =
𝑷𝒓𝒆𝒔𝒆𝒏𝒕 𝒘𝒐𝒓𝒕𝒉 𝒐𝒇 𝒄𝒐𝒔𝒕𝒔

3.3. The Equivalent Uniform Annual Cost (EUAC) Method

In this method, all cash flows (irregular or uniform) must be converted to an equivalent
uniform annual cost that is a year - end amount which is the same year. The alternative with the
least equivalent uniform annual cost is preferred. When the EUAC method is used, the equivalent
uniform annual cost of the alternatives must be calculated for one life cycle only. This method is
flexible and can be used for any type of alternative selection problems. The method is a
modification of the annual cost pattern.

Sample Problems:

Example 1. A coal fired power plant with 300,000 KW rated capacity costs P15,000 per KW installed.
Annual operating cost, P12 M; annual maintenance cost, P 8 M; annual depreciation, P 15 M; interest on
investment per year, 8%; cost of coal, P800 per ton.
If one pound of coal is needed to generate 1 KW –hr, find the total annual cost to operate the
plant. Plant capacity factor is 50%.

Solution:

Investment = (30,000 KW)(P 15,000/KW) = P450 M

1 𝑙𝑏 30,000 𝑥 0.50 𝐾𝑊 𝑃 800 24 ℎ𝑟 365 𝑑𝑎𝑦𝑠

Fuel = x x x x = P52.56 M
𝐾𝑊−ℎ𝑟 2000 𝑙𝑏/𝑡𝑜𝑛 𝑡𝑜𝑛 𝑑𝑎𝑦 𝑦𝑒𝑎𝑟

Annual costs:
Operation = P 12 M
Maintenance = 8M
Depreciation = 15 M
Fuel = 52.56 M
Interest on investment = (P450)(0.080) = 36 M
Total Annual Cost = P 123.56 M

Example 2. The MGC company has a contract with a hauler to transport its naphtha requirements of
3,600,000 liters per year from a refinery in Batangas to its site in Paco at a cost of 21 centavos per liter.
It is proposed that the company buys a tanker with a capacity of 18,000 liters to service its requirements
at a first cost of P800,000 liters is 6 years and a salvage value of P20,000. Other expenses are as follows:
a. Diesel fuel at P5.00 per liter and the tanker consumers 120 liters per round trip from Paco to Batangas
and back.
b. Lubricating oil and servicing is P800 per month.
c. labor including overtime and fringe benefits for one driver and one helper is P 7000 per month.
d. Annual taxes and insurance, 5% of first cost.
e. General maintenance per year is P20,000.
f. Tires cost P21,000 per set and will be renewed every 150 round trips.

What should the MGC company do if a 15% interest rate on investment is included in the analysis?

Solution:

Hauling:
Annual cost = P(0.21)(3,600,000) = P 756,000

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Buying a tanker:
Annual costs:
𝑃800,000−20,000
Depreciation = 𝐹 = P 89,105
,15%,6
𝐴
𝑃3,600,000
Fuel = (120) (5.00) = 120,000
18,000

Oil = (P800)(12) = 9,600

Labor = (P7000)(12) = 84,000
Taxes and Insurance = (P800,000)(0.05) = 40,000
Maintenance:
𝑃3,600,000
Tires = (P21,000) = 28,000
(18,000)(150)
Total Annual Cost = P 390,705

Annual Savings = P 756,000 – P390,705 = P365,295

𝑃365,295
ROR = x 100% = 45.66% > 15%
800,000

❖ Therefore, the company should buy the tanker.

Example 3. A newly built business property containing space for a store and two offices can be
purchased for P 1,200,000. A prospective buyer estimates that during the next 10 years he can obtain
annual rentals of at least of at least P373,000 from the property and that the annual out of pocket
disbursements will not exceed P60,000. He believes that he should be able to dispose of the property at
the end of 10 years at not less than P 700,000. Annual taxes and insurance will total 2.5% of the first
cost.
a. Assume he has sufficient equity capital to purchase the property and that the average return he is
obtaining from his capital is 20%. Would you recommend the investment?
b. What recommendation would you make if he had to borrow 25% of the required capital on the basis of
a year amortization with interest of 18%?
c. If the entire capital can be obtained by floating bonds at 15% that will mature in 10 years, what would
you recommend? Sinking fund interest is 15%.

Solution:
a. Annual revenue = P 373,000
Annual costs:
𝑃1,200,000−𝑃700,000
Depreciation = 𝐹 = P 19,260
,20%,10
𝐴

Disbursements = 60,000
Taxes and insurance = P1,200,000 (0.025) = 30,000
Total annual cost P 109,260
Net annual profit P 263,740

𝑃263,740
ROR = x 100% = 21.98% > 20%
𝑃1,200,000

❖ Therefore, the investment is justified

b. Annual revenue = P 373,000

Annual costs:
𝑃900,000−𝑃700,000
Depreciation = 𝐹 = P 7,000
,20%,10
𝐴

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𝑃1,200,000 (0.25)
Amortization = 𝑃 = 66,760
,18%,10
𝐴

Disbursements = 60,000
Taxes and insurance = P1,200,000 (0.025) = 30,000
Total Annual Cost P164,460
Net Annual Profit P208,540
𝑃208,540
ROR = x 100% = 17.38% < 20%
𝑃1,200,000

❖ The investment is not justified

c. Annual revenue = P 373,000

Annual costs:
𝑃1,200,000−𝑃700,000
Sinking fund deposit = 𝐹 = P24,630
,15%,10
𝐴

Bond interest = P1,200,000(0.15) = 180,000

Disbursements = 60,000
Taxes and insurance = P1,200,000(0.025) = 30,000
Total Annual Cost = P294,630
Net Annual Profit = P78,370

𝑃78,370
ROR = x 100% = 6.53% < 20%
𝑃1,200,000

❖ The investment is not justified

Example 4. A company is considering two types of equipment for its manufacturing plant. Pertinent data
are as follows:
Type A Type B
First Cost P 200,000 P300,000
Annual operating cost P 32,000 P24,000
Annual labor cost P 50,000 P32,000
Insurance and property 3% 3%
taxes
Payroll taxes 4% 4%
Estimated life 10 10

If the minimum required rate of return is 15%, which equipment should be selected?

Solutions:

By the rate of return on additional investment method

Type A
Annual costs:
𝑃200,000 𝑃200,000
Depreciation = 𝐹 = = P 9,850
,15%,10 20.3037
𝐴

Operation = 32,000
Labor = 50,000
Payroll taxes = (P50,000)(0.04) = 2,000
Taxes and insurance = (P200,000)(0.03) = 6,000
Total Annual Cost P 99,850

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Type B
Annual costs:
𝑃300,000 𝑃300,000
Depreciation = 𝐹 = = P 14,776
,15%,10 20.3037
𝐴

Operation = 24,000
Labor = 32,000
Payroll taxes = (P50,000)(0.04) = 1,280
Taxes and insurance = (P200,000)(0.03) = 9,000
Total Annual Cost P 81,056
Annual savings = P 99,850 – P81,056 = P18,794.00

Additional investment = P300,000 – P200,000 = P 100,000

𝑃18,794
ROR on additional investment = x 100% = 18.79% > 15%
𝑃100,000
❖ Type B should be selected

By the annual cost method

Type A.
Annual costs:
𝑃200,000 𝑃200,000
Depreciation = 𝐹 = = P 9,850
,15%,10 20.3037
𝐴
Operation = 32,000
Labor = 50,000
Payroll taxes = (P50,000)(0.04) = 2,000
Taxes and insurance = (P200,000)(0.03) = 6,000
Interest on capital = (P200,000)(0.15) = 30,000
Total Annual Cost P 129,850

Type B
Annual costs:
𝑃300,000 𝑃300,000
Depreciation = 𝐹 = = P 14,776
,15%,10 20.3037
𝐴

Operation = 24,000
Labor = 32,000
Payroll taxes = (P50,000)(0.04) = 1,280
Taxes and insurance = (P200,000)(0.03) = 9,000
Interest on capital = (P300,000)(0.15) = 45,000
Total Annual Cost P 126,056

❖ Since ACB < ACA, type B should be selected

By the present worth cost method

Type A
Annual costs:
(Excluding depreciation)
Operation = 32,000
Labor = 50,000
Payroll taxes = (P50,000)(0.04) = 2,000
Taxes and insurance = (P200,000)(0.03) = 6,000
Interest on capital = (P200,000)(0.15) = 30,000
Total Annual Cost P 90,000

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0 1 2 3 4 5 6 7 8 9 10

P200,000
P 90,000
PWCA = P200,000 + 90,000 (P/A, 15%, 10)
= P200,000 + 90,000 (5.0188)
PWCA = P 651,692.00

Type B
Annual costs:
(Excluding depreciation)
Operation = 24,000
Labor = 32,000
Payroll taxes = (P50,000)(0.04) = 1,280
Taxes and insurance = (P200,000)(0.03) = 9,000
Interest on capital = (P300,000)(0.15) = 45,000
Total Annual Cost P 66,280

0 1 2 3 4 5 6 7 8 9 10

P300K

P 66,280

PWCB = P300,000 + 66,280 (P/A, 15%, 10)

= P300,000 + 90,000 (5.0188)
PWCB = P 632,646

❖ Since PWCB < PWCA for the same period of time, type B should be selected.

By the equivalent uniform annual cost method

Type A

0 1 2 10 0 1 2 10

P 90K P 90K P 90K EUACA EUACA EUACA

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P 200,000

EUACA = P200,000 (A/P,15%,10) + 90,000

= P200,000 (0.1993) + 90,000
EUACA = P129,860

Type B

0 1 2 10 0 1 2 10

P 66,280 P 66,280 P 66,280 EUACB EUACB EUACB

P 300,000

EUACB = P300,000 (A/P,15%,10) + 66,280

= P200,000 (0.1993) + 66,280
EUACB = P126,070

❖ Since EUACB < EUACA for the same period of time, type B is more economical.

Example 5. In marble block quarrying operation, hand rock drills costing P50,000 each are used. It has
a drilling rate of 10 cubic meters of block per month and consumes 60 liters of diesel fuel for compressor
drive per rock drill per cubic meter produced utilizing 1 worker per drill. A modern equipment quarry bar
mounted rock drill is being offered for P180,000 per unit and has a drilling rate of 60 cm per min that will
produce 60 cubic meters of block per month, but consumes 120 liters of diesel fuel for the compressor
drive per 6 cubic meters of block produced, utilizing 2 workers per quarry bar drill. Consider diesel fuel at
P6.00 per liter at the quarries, worker earning P80 per day, 25 days per month, 5 years life of both drills
with 20% salvage value, neglecting cost of money other cost at P500 per cubic meter and marble blocks
sold at P2000 per cubic meter. Would you recommend the purchase of the new equipment? What is the
payout period of the better drill?

Solution:

Hand Rock Drill:

Annual income = (P2000)(10)(12) = P 240,000
Annual costs:
𝑃50,000−(0.2)(𝑃50,000)
Depreciation = = P 8,000
5
Fuel = (60)(10)(12)(6.00) = P 43,200
Salary = (1)(P80)(25)12) = P 24,000
Other cost = (P500)(60)(12) = P 60,000
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Total Annual Cost = P 135,200

Annual Profit P 104,800

𝑐𝑎𝑝𝑖𝑡𝑎𝑙 𝑖𝑛𝑣𝑒𝑠𝑡𝑒𝑑 𝑃50,000

Payout Period = = = 0.477 year
𝑎𝑛𝑛𝑢𝑎𝑙 𝑝𝑟𝑜𝑓𝑖𝑡 𝑃104,800

Modern Rock Drill:

Annual income = (P2000)(60)(12) = P 1,440,000
Annual costs:
𝑃180,000−(0.2)(𝑃180,000)
Depreciation = = P 28,800
5
60 𝑥 12
Fuel = (120)( )(P6.00) = P 86,400
6
Salary = (2)(P80)(25)12) = P 48,000
Other cost = (P500)(60)(12) = P 360,000
Total Annual Cost = P 523,200
Annual Profit P 916,800

𝑐𝑎𝑝𝑖𝑡𝑎𝑙 𝑖𝑛𝑣𝑒𝑠𝑡𝑒𝑑 𝑃180,000

Payout Period = = = 0.196 year
𝑎𝑛𝑛𝑢𝑎𝑙 𝑝𝑟𝑜𝑓𝑖𝑡 𝑃916,800

❖ Purchase the modern rock drill since it has the faster and shorter payout period.

Example 6. A firm is trying to decide which of two devices to install to reduce costs in a particular situation.
Both devices cost $1000 and have useful lives of 5 years and no salvage value. Device A can be expected
to result in $300 savings annually. Device B will provide cost savings of $400 the first year, but savings
will decline by $50 annually, making the second year savings $350, the third-year savings $300, and so
forth. With interest at 7%, which device should the firm purchase? Use the benefit/cost method

Solution:

Device A:
PW of cost = $1,000
PW of benefits = $ 300 (P/A, 7%, 5)
= $ 300 (4.100)
PW of benefits = $1230

𝑷𝑾 𝒐𝒇 𝒃𝒆𝒏𝒆𝒇𝒊𝒕𝒔 $𝟏𝟐𝟑𝟎
B/C = = = 1.23
𝑷𝑾 𝒐𝒇 𝒄𝒐𝒔𝒕𝒔 $𝟏𝟎𝟎𝟎

Device B:
PW of cost = $1,000
PW of benefits = $ 400 (P/A, 7%, 5) – $50 (P/G, 7%, 5)
= $ 400 (4.100) - $ 50 (7.647)
PW of benefits = $1258

𝑷𝑾 𝒐𝒇 𝒃𝒆𝒏𝒆𝒇𝒊𝒕𝒔 $𝟏𝟐𝟓𝟖
B/C = = = 1.26
𝑷𝑾 𝒐𝒇 𝒄𝒐𝒔𝒕𝒔 $𝟏𝟎𝟎𝟎

❖ To maximize the benefit – cost ratio, select Device B

Example 7. Consider the five mutually exclusive alternatives alternative. They have 20-year useful lives
and no salvage value. If the minimum attractive rate of return (MARR) is 6%, which alternative should
be selected?

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Alternatives

A B C D E
Cost $4000 $2000 $6000 $1000 $9000
Uniform
annual benefit 639 410 761 117 785
PW of benefit 7330 4700 8730 1340 9000
Rate of return 15% 20% 11% 10% 6%

Solution:
By inspection, we see that the rate of return for each alternative equals or exceeds the MARR,
that is IRR > MARR, no alternatives are rejected at this point. Now, we need to rearrange these
alternatives in terms of increasing cost and we have:

D B A C E
Cost $1000 $2000 $4000 $6000 $9000
Uniform
annual benefit 117 410 639 761 785
PW of benefit 1340 4700 7730 8730 9000
Rate of return 10% 20% 15% 11% 6%

Increments
B-D A-B C-A E-A
∆ Cost $1000 $2000 $2000 $5000
∆ Annual benefit 293 229 122 146
∆ Rate of return 29.12% 9.63% 1.97% - 4.65%

Incremental internal rate of return (∆IRR)

For B - D: For C – A:
$1000 = $293 (P/A, i%, 20) $2000 = $122 (P/A, i%, 20)
1−(1+𝑖)−20 1−(1+𝑖)−20
$1000 = $293 ( ) $2000 = $122 ( )
𝑖 𝑖
∆IRR = 29.12% ∆IRR = 1.97%
*The B – D increment is satisfactory, therefore * The C – A increment has an unsatisfactory
B is preferred over D 1.97% internal rate of return is less than
the MARR of 6%, so C is discarded.

For A – B: For E – A:
$2000 = $229 (P/A, i%, 20) $5000 = $146 (P/A, i%, 20)
1−(1+𝑖)−20 1−(1+𝑖)−20
$2000 = $229 ( ) $5000 = $146 ( )
𝑖 𝑖
∆IRR = 9.63% ∆IRR = - 4.65 %
* The A – B increment is satisfactory so, A * The E – A increment has an unsatisfactory
Is retained and B is now discarded - 4.65% internal rate of return is less than
the MARR of 6%, so E is discarded.

❖ Therefore, the alternative to be selected is A.

Example 8. Determine the payback period to the nearest year for the following if the MARR is 10%.
First Cost $10,000
Annual Maintenance 500 in year 1, increasing by $200 per year
Annual Income 3,000
Salvage Value 4,000
Useful Life 10 years

Solution:
Year Net Income Sum

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1 2,500 2,500
2 2,300 4,800
3 2,100 6,900
4 1,900 8,800
5 1,700 10,500 > 10,000
6 1,500 12,000
7 1,300 13,300
8 1,100 14,400
9 900 15,300
10 700 16,000

❖ Payback period is at year 5.

Example 9. Barrick Gold Mining Inc. must purchase a new coring machine that costs $30,000 and is
expected to last 12 years, with a salvage value of $3,000. The annual operating expenses is expected to
be $9,000 the first year and increase by $200 each year thereafter. The annual income is expected to be
$12,000 per year. If Barrick’s MARR is 10%, determine the net future worth of the machine purchase.
Was the purchase a wise investment?

Solution:

NFW = - 30,000 (F/A, 10%,12) – [ 9,000 + 200(A/G, 10%,12)] (F/A,10%,12) + 12,000

(F/A,10%,12) + 3000

NFW = - $45, 754

❖ Therefore, it is not a wise investment.

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VI. LEARNING ACTIVITIES

NAME: _________________________ SCHEDULE: __________

COURSE & YEAR: _______________ DATE: ____________

ACTIVITY 3

Direction: Solve the following economic problems systematically and select what alternative is justifiable.

1. An industrial plant is considering the purchase of a centrifugal pump. Three offers were received and
basis of selection have been tabulated as follows:

Offer A Offer B Offer C

Price of pump P60,000 P96,000 P120,000
Economic life, years 3 5 10
Salvage value at end
of economic life 5,000 10,000 8,000
Yearly maintenance
cost 10,000 6,000 5,000

If cost of money is 14%, what offer would you recommend to be purchased? Use the rate of return
method, the annual cost method, present worth method and equivalent uniform annual cost method for
the evaluation.

2. Type X tooling for making a certain part would cost P 50,000. The variable cost with this tooling be
P2.60 per hour, set up cost would be P700 and processing time would be 0.12 hour per piece.
Type Y tooling would cost P 10,000 and with its variable cost would be P2.20 per hour set up cost
would be P1300 and processing time would be 0.15 hour per piece.
The hourly cost of the machine with which the tooling would be used is P30 per hour and labor
cost would be P 25.00 per hour. Each year, 10,000 units are produced in three different sizes: 3000 units
of size one; 3000 units of size two and 4000 units of size three. It is believed that either type of tooling
would be adequate for a total of 30,000 pieces before renewal. Taxes and insurance would be 3% of the
first cost per year for either type of tooling.
If capital is worth 20%, which type of tooling would be more economical?

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VII. EVALUATION (Note: Not to be included in the student’s copy of the IM)

VIII. ASSIGNMENT

NAME: __________________________ SCHEDULE: ______________

COURSE & YEAR: _________________ DATE: _______________

ASSIGNMENT 3

Direction: Solve the following economic problems systematically and select what alternative is justifiable.

1. Looney Lyn has just won $20,000 and wants to invest it for 12 years. There are three plans available
to her.
Plan A. A savings account that pays 3.75% per year compounded daily.
Plan B. A money market certificate that pays 6% per year compounded semiannually.
Plan C. An investment account that based on past experience is likely to pay 8.5% per year.

If Looney Lyn does not withdraw the interest, how much will be in each of the three investment plans at
the end of 12 years? What plan would she choose?

2. Fish or Cut Bait excursion boats has just a new 22 passenger skimmer for use over the next 10 years.
The cost of boat was $80,000. The income associated with the boat is expected to be $15,000 each year
and the costs are estimated to be $2,000 of the first year and increase by $500 per year each year
thereafter. The salvage value of the boat is estimated to be $5000. If the MARR is 5%, what is the payback
period of the boat?

3. Zill, Anderson and Pope (ZAP) Bug Killers Inc. recently purchased new electrical shock equipment
guaranteed to kill any flying insect. The equipment cost $16,250 and has a useful life of 4 years. Each
year the equipment will result in income of $5,500. The cost incurred to operate the machine are
estimated to be $500the first year and increase by $250 year thereafter. When the equipment is disposed
of it is expected to have a value of $800. If ZAP’s MARR is 8%, what is the net future worth of the
equipment? Was the purchase a wise investment?

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IX. REFERENCES

A) Book/Printed Resources
De Garmo, EP. (1988). Engineering Economy, 8th Edition. Macmillan Publishing Company.

Park, C.S. (2013). Engineering Economics, 3rd Edition. Pearson Education, Inc.

Sta. Maria, Hipolito (1993). Engineering Economy, 2nd Edition. National Book Store.

B) e-Resources
Engineering Economy. Retrieved from https://www.EngineeringBookspdf.com

Engineering Economy. Retrieved from https://www.youtube.com/watch?v=zpZGq1rTWEU&list

=PLvJR-crn9YFxZ_kvKXJr7_QVkPbs81qUj&index=4

Engineering Economy Module 1: Introduction. Retrieved from https://www.youtube.com/watch?

v=cxZX5myCeMA.

Introduction to Engineering Economy. Retrieved from https://www.youtube.com/watch?v=2AhYE-

AY1AM.

Principles of Economics. Retrieved from https://opentextbc.ca/principlesofeconomics/

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