AKSUM INSTIUTE OF TECHNOLOGY

Development/engineering economics(COTM 5262)

Prepared by Hayelom T.

1
1. Introduction
WHAT IS ECONOMICS?
 “Economics is the study of how people and society choose
to employ scarce resources that could have alternative uses in
order to produce various commodities and to distribute them
for consumption, now or in the future
 Or it is the study of how people choose to use resources.

 Resources include the time and talent people have

available, the land, buildings, equipment, and other tools
on hand, and the knowledge of how to combine them to
create useful products and services.

2
1. Introduction
WHAT IS ENGINEERING ECONOMICS?
 Engineering economics is the application of economic principles
and techniques to engineering problems or the evaluation of
design and engineering alternatives.
 It deals with the concepts and techniques of analysis
useful in evaluating the worth of systems, products,
and services in relation to their costs
 For example in comparing the comparative costs of two
alternative capital projects or in determining the optimum
engineering course from the cost aspect.
 The role is to assess the appropriateness of a given project,
estimate its value, and justify it from an engineering standpoint.

3
1. Introduction
 Engineering economics is important to all
fields of engineering because no matter how
technically sound an engineering project is, it
will fail if it is not economically feasible.
 Engineering economic analysis is often applied
to various possible designs for an engineering
project in order to choose the optimum design,
thereby taking into account both technical and
economic feasibility.

4
1. Introduction
It provides a rational and systematic approach for
evaluating different economic decision
E.G.
◦ Purchase of a new manufacturing equipment
◦ Evaluating different manufacturing methods in terms of
Economic value to the company
◦ Replacing existing manufacturing equipment or method
Why Is Engineering Economics Important?
 Engineers , Architects DESIGN things and perform PROJECTS
 Therefore, engineers and Architects must be concerned with the
economic aspects of designs that they recommend, and projects that
they perform
5
1. Introduction
 Annual cost analysis (Annuities) computes the
annual rate of return for a project or projects.
A value called the minimum attractive rate of return
(MARR) is also computed.
 Generally, a project must meet or exceed the MARR
to be considered feasible.
 If two or more projects meet this rate, other criteria
are also considered.

3/7/2024 6
1. Introduction
 For government engineering projects, a method
called benefit/cost analysis is often used.
 This method converts the all benefits and costs of
a project into monetary values, and then divides the
total benefits by the total costs.
 As a general rule, the project is considered
acceptable if this ratio is greater than one.

3/7/2024 7
1. Introduction

 In manufacturing engineering, a method

called break-even analysis is often used.
 This is used to determine the percent
capacity for the manufacturing operation
at which cost is equal to income.
 A company could use the break-even
analysis method to determine the
minimum amount it must produce in a
month to turn a profit.
3/7/2024 8
1. Introduction

 Engineers may also use economics to

calculate depreciation of value.
For example, they could calculate the value of a
tool that a company is considering purchasing.
Methods for calculating depreciation include;
book value,
straight-line depreciation, and
 accelerated cost recovery system.
3/7/2024 9
1. Introduction
 All disciplines of engineering employ engineering
economics.
 Most university and college engineering departments
require a course in engineering economics, or include
economic analysis in other engineering coursework.
 Engineering economics is a required section of the
Fundamentals of Engineering exam, which is required for
engineers who desire to attain professional
licensure.

3/7/2024 10
1. Introduction
 Many basic economic principles may be
applied in an engineering economic
analysis, depending on their applicability.
 Time value of money is one such
principle with wide applicability.
 This principle is used to calculate the future
value of something given the present value,
or the present value given the future
value, at a given interest rate.
3/7/2024 11
1. Introduction
 For example, time value of money
may be used to calculate how much a
project will cost once it is actually
completed;
 Annual investments or withdrawals may
also be calculated.
 A cash-flow diagram is often used to aid
in the calculation of the time value of
money.
3/7/2024 12
1. Introduction
 When comparing costs among two or
more possible alternatives, engineering
economics may use either present or future
worth analysis or annual cost.
 Present or future worth analysis converts all
the costs of a project into equivalent present
or future worth.
 The time period of analysis must be the same
for all options for this method to be valid.

3/7/2024 13
1. Introduction
WHY DO ENGINEERS NEED TO LEARN ABOUT
ECONOMICS?
 Ages ago, the most significant barriers to
engineers were technological. The things that
engineers wanted to do, they simply did not yet
know how to do, or hadn't yet developed the
tools to do.
 There are certainly many more challenges like
this which face present-day engineers. However,
we have reached the point in engineering where it is
no longer possible, in most cases, simply to design
and build things for the sake simply of designing
and building them.

3/7/2024 14
1. Introduction
WHY DO ENGINEERS NEED TO LEARN ABOUT
ECONOMICS?
 Natural resources (from which we must build
things) are becoming more scarce and more
expensive. We are much more aware of negative
side-effects of engineering innovations (such as
air pollution from automobiles) than ever
before.
 For these reasons, engineers are tasked more
and more to place their project ideas within the
larger framework of the environment within a
specific planet, country, or region.
3/7/2024 15
1. Introduction
WHY DO ENGINEERS NEED TO LEARN
ABOUT ECONOMICS?
 Engineers must ask themselves if a particular project
will offer some net benefit to the people who will be
affected by the project, after considering its inherent
benefits, plus any negative side-effects (externalities),
plus the cost of consuming natural resources, both in
the price that must be paid for them and the realization
that once they are used for that project, they will no
longer be available for any other project(s).
 Simply put, engineers must decide if the benefits of a
project exceed its costs, and must make this comparison
in a unified framework

3/7/2024 16
1. Introduction
 Why Engineering Economics?
 It is used to answer many different questions
◦ Which engineering projects are worthwhile?
 Has the mining or petroleum engineer shown that the mineral
or oil deposits is worth developing?
◦ Which engineering projects should have a higher
priority?
 Has the engineer shown which factory improvement projects
should be funded with the available dollars?
◦ How should the engineering project be designed?
 Has the engineer chosen the best thickness for insulation?
 etc

3/7/2024 17
generally
 ENGINEERING ECONOMICS
INVOLVES:
 FORMULATING, ESTIMATING,
AND EVALUATING ECONOMIC
OUTCOMES When choices or
alternatives are available by using
specific mathematical relationships
to compare the cash flows of the
different alternatives

3/7/2024 18
1.1 Cash flow
Cash-Flow Concepts
 Cash flow is the stream of monetary (dollar)
values—costs (inputs) and benefits
(outputs)—resulting from a project
investment.
OR
 It is the sum of money recorded as receipts
or disbursements in a project’s financial
records.

3/7/2024 19
1.1 Cash flow
 Cash-Flow Diagrams
 It is difficult to solve a problem if you cannot see it.
The easiest way to approach problems in economic analysis is to
draw a picture.
The picture should show three things:
1. A time interval divided into an appropriate number of equal periods
2.All cash outflows (withdrawals, expenditures, etc.) in each period
3.All cash inflows (deposites, income, etc.) for each period

Unless otherwise indicated, all such cash flows are considered to

occur at the end of their respective periods

3/7/2024 20
 1.1 Cash flow
 The picture (A cash-flow diagram (CFD), as
used in engineering economic analysis, is a
graphical representation of when all cash flows
occur.
 Cash flows can be positive or negative.
 Positive cash flows (cash inflows) increase
the funds available to the company;
therefore, they include both receipts and
revenue.
 Negative cash flows (cash outflows) are
deductions from the company’s funds; hence,
they include first cost, annual expenses,
and other cash disbursements.
3/7/2024 21
1.1 Cash flow
 The difference between several receipts and
disbursements that occur within a given interest
period is called the net cash flow.
 Cash-flow diagrams can be drawn on the
basis of cash inflows, cash outflows, and net cash
flows. F
1 2 ……………. N
P

3/7/2024 22
1.1 Cash flow
 CFDs are based on the following
assumptions
 Interest rate is computed once in a period.

 All cash flows occur at the end of the period.

 All periods are of the same length.

 The interest rate and the number of periods are of the same
length.

 Negative cash flows are drawn downward from the time line.

 Positive cash flows are drawn upward from the time line.

3/7/2024 23
1.1 Cash flow
 Engineering economic analysis utilizes the following terms and
symbols for CFDs:
 P -cash-flow value at a time designated as the present. This is
usually at time 0. It may also be called the present value (PV) or the
present worth (PW) dollars.
 F - cash-flow value at some time in the future. It is also called the
future value (FV) or the future worth (FW) dollars.
 A - series of equal, consecutive, end-of-period amounts of money.
This is also called the annual worth (AW) or the equivalent uniform
annual worth (EUAW) dollars per period.

3/7/2024 24
1.1 Cash flow
 G - a uniform arithmetic gradient increase in period-by-period

payments or disbursements.

 n - number of interest periods (days, weeks, months, or years).

 i - interest rate per time period expressed as a percentage.

 t - time, stated in periods (years, months, days).

3/7/2024 25
1.1 Cash flow
 Notation
 To simplify the subject of economic
analysis, symbols are introduced to
represent types of cash flows and interest
factors. The following symbols will be
used here:
◦ P- Present sum of money ($)
◦ F - Future sum of money ($)
◦ N - Number of interest periods
◦ i - Interest rate per period (%)

3/7/2024 26
1.1 Cash flow
Discount Factors and Equivalence

27
1.2 Equivalence
 Equivalence Concept
 The concept of equivalence means that payments that differ in
magnitude but are made at different time periods may be
equivalent to one another.
 The cash flow factors can be used to determine the equivalent
value of money at a time period different from the one in which the
money is paid or received.
 This involves consideration of time and the interest rate.
For example, a contractor might be interested in purchasing a truck in
five years and wants to determine how much he or she should invest
today to have sufficient funds at the end of the five-year period.
Another example might be a contractor who is considering either
purchasing or leasing a crane.

3/7/2024 28
1.2 Equivalence
 Each alternative has differing costs that are
incurred at different times. To compare the two,
the contractor decides to determine an
equivalent cost for each based on its present
worth, which means determining an equivalent
cost at today's value.
 To be meaningful, any economic comparison
must be based on equivalent costs at the
same point in time.
 In other words, comparing a future cost of one
alternative with the present worth cost of a
second alternative is not valid, and therefore not
meaningful.
3/7/2024 29
1.2 Equivalence
 Establishing Economic Equivalence
 A typical engineering economic decision involves two
dissimilar types of dollar amounts.
 First, there is the investment, which is usually made in
a lump sum at the beginning of the project, a time
that for analytical purposes is called today, or time 0.
 Second, there is a stream of cash benefits that are
expected to result from this investment over a period
of future years. In such a fixed asset investment funds
are committed today in the expectation of earning a
return in the future.
 In the case of a bank loan, the future return takes the
form of interest plus repayment of the principal.
 This is known as the loan cash flow.

3/7/2024 30
1.2 Equivalence
 In the case of the fixed asset, the future return takes
the form of cash generated by productive use of the
asset.
 The representation of these future earnings along
with the capital expenditures and annual expenses
(such as wages, raw materials, operating costs,
maintenance costs, and income taxes) is the project
cash flow.
 This similarity between the loan cash flow and the
project cash flow brings us an important
conclusion—that is, first we need to find a way to
evaluate a money series occurring at different points
in time. Second, if we understand how to evaluate a
loan cash flow series, we can use the same concept
to evaluate the project cash flow series.
3/7/2024 31
1.2 Equivalence
 Generally, Different sums of money at different
times can be equal in economic value.
 For example, if the interest rate is 6% per
year, a $100 today (present time) would be
equivalent to $106 one year from today.
Also, $100 today is equivalent to $94.34 one
year ago.
Therefore, $94.34 last year, $100 now, and
$106 one year from now are equivalent when
the interest rate is 6% per year
3/7/2024 32
1.3 payment series
 Whenever one can identify patterns in cash
flow transactions, one may use them in
developing concise expressions for computing
either the present or future worth of the
series. For this purpose, we will classify cash
flow transactions into three categories:
(1) Simple cash flow series (Equal or even &
Un-even)
(2) Linear gradient series
(3) Geometric gradient series

3/7/2024 33
1.3 payment series
 1. Simple cash flow series ( Equal cash flow series ): Probably the
most familiar category includes transactions arranged as a series of
equal cash flows at regular intervals, known as an equal-payment
series (or uniform series)

 This factor helps you answer the question: “What is the single
future value that would accumulate from a series of equal
payments occurring at the end of succeeding annual interest
periods?”

3/7/2024 34
1.3 payment series
 Single Payments

 Single payments may occur either today or at some time in the

future. P is used to indicate a sum paid or received today, and F is
used to indicate a future sum.

 Let's determine the future value of $10 invested at 6% for one year.

$10 (1 + 0.06) = $10.60

 This can be written symbolically as

F = P (1 + i)

 where i is the interest rate. For n periods, the formula becomes

F = P (1+ i)n

3/7/2024 35
1.3 payment series
 Example: single payment
 A contractor plans to purchase a pickup truck in 5 years. How much
should the contractor invest at 6% interest today to have the
$30,000 needed to purchase the truck at the end of the 5 years?
Solution
In this problem, the purchase price is a known future value, and the
unknown is the present worth amount. Mathematically, this can be
written as
P = F/ (1+ i)n = $30,000 / (1 + 0.06)5
Using our shorthand notation, it is written as
P = F (P/F, i, n) = ($30,000) (P/F, 6%, 5)
Note that the unknown is always the numerator in the shorthand
notation (P/F), and the known is the denominator.
Looking at tables, we find the factor value to be 0.747. Solving the
equation yields the following answer:
P = ($30,000) (0.747) = $22,410

3/7/2024 36
 1.3 payment series
Example; equal payment series
Suppose you make an annual contribution of $3000 to your
savings account at the end of each year for 10 years. If
your savings account earns 7% interest annually, how
much can be withdrawn at the end of 10 years?

Solution
F= A(1+i)^n -1
i
F=P(F/A,7%,10)=$3000(13. 8164)=$41 ,449. 20

3/7/2024 37
1.3 payment series
 2. Linear Gradient Series: While many transactions
involve series of cash flows, the amounts are not always
uniform: yet they may vary in some regular way. One
common pattern of variation occurs when each cash flow
in a series increases (or decreases) by a fixed amount.
 This could be either uniform(even series/linear
gradient series ) OR uneven series
 A 5-year loan repayment plan might specify, for example, a
series of annual payments that increased by $50 each year.
We call such a cash flow pattern a linear gradient series
because its cash flow diagram produces an ascending (or
descending) straight line.
 In addition to P, F, and A, the formulas used in such
problems involve the constant amount, G,of the change in
each cash flow.

3/7/2024 38
1.3 payment series
 Example; uneven payment series P=p1+p2+p4

3/7/2024 39
uneven payment series P=p1+p2+p4

P1=25,000(P/F,10%,1)=22,727
P2=3,000(P/F,10%2)=2,479
P4=5,000(P/F,10%,4)=3,415
Therefore,
P=
P1+P2+P4=22,727+2,479+3,415=28,622

3/7/2024 40
1.3 payment series
3. Geometric Gradient Series: Another
kind of gradient series is formed when the
series in cash flow is determined, not by
some fixed amount like $50, but by some
fixed rate, expressed as a percentage.
For example, in a 5-year financial plan for a
project, the cost of a particular raw material
might be budgeted to increase at a rate of
4% per year. The curving gradient in the
diagram of such a series suggests its name:
 In the formulas dealing with such series, the
rate of change is represented by a lowercase
g.

3/7/2024 41
1.3 payment series

3/7/2024 42
1.4 Time value of money

3/7/2024 43
1.4 Time value of money
 Would you rather have:

$100 today, or
$100 a year from now?

 Change in the amount of money (due

to the impact of interest or cost of money)
over time is called time value of money

3/7/2024 44
1.4 Time value of money
 Impact of Interest
 Money has a time value because it can earn more
money over time (earning power).
 Money has a time value because its purchasing
power changes over time (inflation).
 Time value of money is measured in terms of
interest rate.
 Interest is the cost of money—a cost to the
borrower and an earning to the lender

3/7/2024 45
1.4 Time value of money

3/7/2024 46
1.4 Time value of money
 The changes in the value of a sum of money over
time can become extremely significant when we
deal with large amounts of money, long periods
of time, or high interest rates.
 For example, at a current annual interest rate of
10%, $1 million will earn $100,000 in interest in
a year; thus, waiting a year to receive $1 million
clearly involves a significant sacrifice.
 In deciding among alternative proposals, we must
take into account the operation of interest and
the time value of money to make valid
comparisons of different amounts at various
times.
3/7/2024 47
1.4 Time value of money
 SIMPLE VERSU SIMPLE INTEREST:
 Simple interest:The practice of charging
an interest rate only to an initial sum(principal
amount).
 Compound interest: the practice of
charging an interest rate to an initial sum and to
any previously accumulated interest that has not
been withdrawn.
3/7/2024 48
1.4 Time value of money
 Simple interest is calculated using the
principal only (i.e. the original investment
or original loan), ignoring any interest that
has been accrued in preceding interest
periods

3/7/2024 49
1.4 Time value of money

 E.g, End of Beginning Interest Ending

Year Balance earned Balance
 P = $1,000
 i = 10% 0 $1000
 N = 3 years 1
2
$1000
$1100
$100
$100
$1100
$1200
3 $1200 $100 $1300

3/7/2024
1.4 Time value of money
 Simple Interest
 Interest earned/paid is directly proportional to
capital involved.
 I=P*i*n
 Eg. $ 1000 loan for 2 years at 10 % per year – no
compounding
 I = P * i * n = 1000 * .10 * 2 = $200
 Payback = F = P + I
 = 1000 + 200 = $1200
3/7/2024 51
1.4 Time value of money
 Compound Interest
 Compound interest is calculated using the principal plus the total
amount of interest accumulated in previous periods.
 Thus, compound interest means “interest on top of interest”.
 Example: If you borrow $1,000 at 6% per year compound
interest, compute the total amount owed after three year period?
 Soln;
Interest for Year 1 = $1,000 X 0.06 = $60
Total amount due after year 1 = $1,000 + $60 = $1,060
Interest for year 2 = $1,060 X 0.06 = $63.60
Total amount due after year 2 = $1,060 + $63,60 = $1,123.60
Interest for year 3 = $1,123.60 X 0.06 = $67.42
Total amount due after year 3 = $1,123.60 + $67.42 = $1,191.02

3/7/2024 52
1.4 Time value of money
 Thus, with compound interest, the original
$1,000 would accumulate an extra $1,191.02 -
$1,180 = $11.02 compared to simple interest
in the three year period.
 Therefore, if an amount of money P is invested
at some time t=0, the total amount of money
(F) that would be accumulated after one year
would be:

3/7/2024 53
1.4 Time value of money
 At the end of the second year, the total
amount of money accumulated (F2) would
be equal to the total amount that had
accumulated after year 1 plus interest from
the end of year 1 to the end of year 2.
F2=F1+F1i
=P (1+i) +P (1+i) i
=P (1+i+i+i2)
=P (1+2i+i2)
=P (1+i)2

3/7/2024 54
1.4 Time value of money
 Similarly, the total amount of money
accumulated at the end of year 3 (F3) would
be equal to the total amount that had
accumulated after year 2 plus interest from
the end of year 2 to the end of year 3.
F3=F2+F2i
=[P (1+i) +P (1+i)i ] +[ P (1+i) +P (1+i) i]i
= P (1+i) (1+i+i+i2)
= P (1+i) (1+i) 2
= P (1+i)3

3/7/2024 55
1.4 Time value of money
 Thus from the preceding values, it is
evident that by mathematical induction
that the formula for calculating the total
amount of money (F) after (n) number of
years, using compound interest (i) would
be:

3/7/2024 56
1.5 depreciation of an asset
Depreciation is important because it affects the taxes that firms pay.

TAXES proportional to TAXABLE INCOME (PROFIT – COSTS)

COSTS = Maintenance Cost + Depreciated Initial Cost
Roughly speaking,
depreciation is a decrease in value of an asset each year.
Example
• A firm has 1,000,000 of taxable income. If its tax rate is 25%, it would
pay
250,000 in taxes ignoring depreciation.
• If it can deduct 50,000 in depreciation charges, its net taxable income
will be 950,000.Thus, it would pay taxes of 0.25 (950,000) = 237,500.
• Depreciation saves 250,000 – 237,500 = 12,500 = 0.25(50,000). If it
could deduct more than 50,000 it would pay even less taxes.
• Individual investors encounter similar situations. If you invest 10,000
and get a 10% return, your taxable income is 1,000.
If you are in the 25% tax bracket, the government takes 250, so your
net return is 750  7.5%.

3/7/2024 57
 Depreciation
Market value is the value others would
place on the property of interest
Depreciation can mean
◦ a decrease in market value,
◦ a decrease in the value to the owner.

Important reasons for depreciation include

◦ deterioration, A machine can begin to wear out and
◦ obsolescence. no longer perform its function as well as
when it was new.
Accountants define depreciation as follows:
the systematic allocation of the cost of an asset over its useful, or depreciable,
life.

The latter definition is used for determining taxable income – hence, income
taxes.

3/7/2024 58
Depreciation: Requirements

In general business assets can only be depreciated if

they meet the following basic requirements:

 The property must have a useful life that can be determined, and
this life must be longer than one year

 The property must be an asset that decays, gets used up, wears out,
becomes obsolete, or loses value to the owner due to natural
causes

3/7/2024 59
Depreciation: Overview

Definition
 The number of years over which a machine( an asset) is
depreciated is called its depreciable life

 Depreciation is a business expense the government allows to

offset the loss in value of business assets.

 Depreciation deductions reduce the taxable income of

businesses and thus reduce the amount of tax paid.

3/7/2024 60
 Depreciation Calculation Fundamentals

Example. Year Depreciation Book Value

(dt ) (BVt )
A PC costs 1,800. Its annual
0 1,800
depreciation charges are 800, 600,
and 350 for three years. 1 800 1,000
2 600 400
3 350 50
 1,800 is called the cost, initial cost, or cost basis.
 dt denotes the depreciation deduction in year t.
 Thus d1 = 800, d2 = 600, d3 = 350.
 BVt denotes the book value at the end of year t.

BV0 = cost basis (e.g., 1,800)

BV1 = BV0 – d1 = cost basis – d1 (e.g., 1,000)
BV2 = BV1 – d2 = cost basis – (d1 + d2) (e.g., 400)
BV3 = BV2 – d3 = cost basis – (d1 + d2 + d3) (e.g., 50)

3/7/2024 61
Depreciation Calculation Fundamentals
BVt = cost basis – (d1 + d2 + … + dt)
This equation is used to compute the book value of an asset at the end
of any time t.
Book value can be viewed as the remaining unallocated cost of an asset:

Book value = Cost – Depreciation charges made to date

Note:
If the item has a salvage value then the final book value will be the
salvage value.
Example:

The book value of the PC declines during the useful life from a value of

B = 1,800 at time 0 in the recovery period, to a value of S = 50 at time 3

3/7/2024 62
Depreciation Methods

Some of the common methods used to calculate

deprecation included

 Straight line,

 Sum-of-the-years digits, and

 Declining balance.
Each method requires estimates of the asset’s useful life and

salvage value.

3/7/2024 63
 Straight Line (SL) Depreciation
Year Initial Book Depr. EOY Book
Value Charge Value
Example 0 900
An asset has a cost of B = 900, 1 Cost = 900 166 734
a useful life of N = 5 years, and 2 734 166 568
an EOL salvage value of 3 568 166 402
S = 70. 4 402 166 236
5 236 166 Salvage Value
With straight line depreciation, 70
Total Depr.: 830
we would compute the
following: Book Value
Initial
Cost
900
Annual depreciation charge:
di = (B-S)/N Salvag
e Value
= 830/5 = 166.

70
The book value of the asset
decreases by $166 each year 1 2 3 4 5
3/7/2024
N Useful Life 64
 Sum-Of-Years Digits (SOYD) Depreciation
Example
An asset has a cost of B = 900, a useful life of N = 5 years, and an EOL
salvage value of S = 70. With SOYD depreciation, we would compute
the following
Year Life Multiplier B-S Depreciation Charge EOY Book Value
0 900
1 5 5/15 830 277 623
2 4 4/15 830 221 402
3 3 3/15 830 166 236
4 2 2/15 830 111 125
5 1 1/15 830 55 70

15 1 830

The product of the multiplier and B-S for the year is the depreciation charge for
the year. Note the multipliers add to 1.

3/7/2024 65
Sum-Of-Years Digits (SOYD) Depreciation

dt=(N+1-t)/SOYD(B-S)= 2(N+1-t)/[N(N+1)](B-S)

SOYD depreciation causes larger decreases in book value in earlier

years than in later years.

Book Value SOYD Depreciation

looks like this.

Salvage value N

3/7/2024 66
Declining Balance Depreciation
For straight line depreciation with N years, the rate of decrease each year is 1/N.
Declining balance depreciation uses a rate of either 150% or 200% of the straight-line rate.
Since 200% is twice the straight-line rate, it is called double declining balance (DDB).
The DDB equation for any year is

DDB depreciation dt = (2/N) ( Book value)

Book value = Initial cost – total charges to date,
So,
DDB deprec. dt = (2/N) (Initial cost – total charges to date)
It can be shown for DDB, that the depreciation schedule in year t is given by:
DDB depreciation in year t = (2B/N)(1 – 2/N)t-1
For 150% declining balance depreciation, the depreciation in year t is given by:
DDB depreciation in year t =(1.5 B/N)(1 – 1.5/N)t-1.
we just replace each “2” in the DDB formula by “1.5”.

3/7/2024 67
Declining Balance Depreciation: Example
Example
An asset has a cost of B = 900, a useful life of N = 5 years, and an EOL salvage value of S = 70.
With DDB depreciation, we would compute the following

Year Multiplier Cost – Depreciation EOY

depreciation Charge Book
charges to date Value
0 900
1 2/5 900 360 540
2 2/5 540 216 324
3 2/5 324 130 194
4 2/5 194 78 116
5 2/5 116 46 70
830

If the salvage value of this example had not been 70, a modification of DDB
would be
necessary.
Several possibilities exist:
• stop further depreciation when the book value equals the salvage value; 68
Exercise
• An equipment costs 10,000 birr with a
salvage value of 2,000 birr. Useful life of
the item in taxpayer’s hands is 5 years.
calculate,
the depreciation value in the useful life of
this equipment using all the three
methods

3/7/2024 69
3/7/2024 70