ECO 017

Engineering Economics

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 PHINMA Education
Syllabus

PEN CODE: ECO 017 Credit: 3 units

PEN Subject Title: Engineering Economics Prerequisite: 2nd Yr Standing

I. Course Description

This basic engineering science subject will include money-time relationships or time value
of money. This course covers the study of economic problems which possibly considers
comparison of alternatives and establishing bases for decision. It deals with the application of
certain basic principles of economics and theories of investment to engineering problems
involving cost.

II. Course Objectives

At the end of semester, you should be able to understand and appreciate the significance
of the fundamental concepts and principles of engineering economics, analyze and solve
engineering problems involving present worth, future worth, annuities, perpetuity, depreciation,
and break-even analysis.

III. Course Topics, Topic Coverage Dates, and Time Allotment

Lesson Topic Week

1 Introduction to Engineering Economics
1
2 Simple Interest and Cash-Flow Diagram
3 Compound Interest 2
Quiz 3
4 Continuous Compounding
4
5 Discount and Inflation
EXAMINATION WEEK 5
6 Ordinary Annuity
6
7 Annuity Due
Quiz
7
8 Deferred Annuity
9 Perpetuity
10 8
Capitalized and Annual Cost
EXAMINATION WEEK 9
11 Gradient
10
12 Depreciation
Quiz
11
13 Sum-of-Years Digit Method of Deprecation
14 Sum-of-Years Digit Method of Deprecation -
12
Part 2
 15 Break-Even Analysis
16 Mathematical Expression for Break-even
EXAMINATION WEEK 13

IV. Grading System

The Final Grade is computed as follows:

Final Grade = 0.2P1 + 0.2P2 + 0.2P3 + 0.4FE ≥ 60%

Periodical Grade (P1, P2, or P3) = (Class standing + Periodic Exam)/2

= 50%CS + 50% Periodic Exam

 Class Standing = 60% quiz + 40% class participation

 40% Class Participation = 20% Module Activities + 20% Other Activities

V. References

 Sta. Maria, Hipolito B. Engineering Economy . 3rd edition

 Gillesania. Engineering Mathematics. Vol. 2
 www.analyzemath.com/finance/interests_p roblems_sol.html
 investopedia.com
 https://cleartax.in/s/break-even-analysis

VI. Course Requirements

 Attend the class regularly.

 Actively participate in all class activities.
 Accomplish and submit student activity sheets.
 There will be four periodic examinations: P1 Exam, P2 Exam, P3 Exam, and Final Exam
with a Passing Score (PS) ≥ 60%.
 A student who misses a quiz or an exam with a valid reason (ex. A student who fails to
take the exam because of health reasons shall first present a valid medical certificate to
justify his condition) will be allowed to take a make-up quiz or examination which will be
given within five days after the original date of the quiz or examination but also within the
period of encoding of grades.
 A student who incurs a failing grade in the Final Examination gets a Final Grade of INC.
The student is required to take a completion examination. The final examination grade
should be passing. If in one academic year the student fails to change his/her grade from
an INC t o a passing grade, he/she will be given a grade of No Credit (NC).
 ECO 017: Engineering Economics
Module #1 Student Activity Sheet

Name:_________________________________________________________ Class number: ______

Section: ____________ Schedule: ________________________________ Date: _______________

Lesson Title: Introduction to Engineering Economics Materials:

Learning Targets: Ballpoint and or highlighter
At the end of the module, you should be able to:
1. Enlist the principles of engineering economics References:
2. Familiar with the basic concepts and terminologies in Engineering Economy by Hipolito
engineering economics B. Sta. Maria, 3rd Ed
Engineering Mathematics vol 2 by
Gillesania

A. LESSON PREVIEW/REVIEW

Introduction

The need for engineering economy is primarily motivated by the work that engineers do in performing
analysis, synthesizing, and coming to a conclusion as they work on projects of all sizes. In other words,
engineering economy is at the heart of making decisions. These decisions involve the fundamental
elements of cash flows of money, time, and interest rates. This chapter introduces the basic concepts and
terminology necessary for an engineer to combine these three essential elements in organized,
mathematically correct ways to solve problems that will lead to better decisions.

Before we begin to develop the fundamental concepts upon which engineering economy is based, it would
be appropriate to define what is meant by engineering economy. In the simplest of terms, engineering
economy is a collection of technique that simplify comparisons of alternatives on an economic basis.
Engineering economy begins only after the alternatives have been identified.

B.MAIN LESSON

Activity 2: Content Notes

DEFINITIONS

Engineering is the profession in which knowledge of the mathematical and natural sciences gained by
study experience and practice is applied with judgment to develop ways to utilize economically the material
and forces of nature for the benefit of mankind.

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Name:_________________________________________________________ Class number: ______

Section: ____________ Schedule: ________________________________ Date: _______________

Economics is a social science concerned with the production, distribution, and consumption of goods
and services. It studies how individuals, businesses, governments, and nations make choices about how to
allocate resources.

Engineering Economics is a subject of vital importance to Engineers. It is the analysis and evaluation
of the factors that will affect the economic success of engineering projects to the end that a recommendation
can be made which will insure the best use of capital of the project.

CONSUMER AND PRODUCER GOODS AND SERVICES

Consumer goods and services are those products and services are directly consumed or use by a
consumer after its purchase and satisfy their wants
Producer goods and services are used by producers to produced consumer goods and services or other
producer goods
DEMAND

Demand is the quantity of certain commodity that is bought at a certain price at a given place and time.

ECONOMIC ENVIRONMENT

Much less of a quantitative nature is known about economic environments -- this is due to economics
being involved with the actions of people, and the structure of organizations.

Satisfaction of the physical and economic environments is linked through production and construction
processes. Engineers need to manipulate systems to achieve a balance in attributes in both the physical and
economic environments, and within the bounds of limited resources. Following are some examples where
engineering economy plays a crucial role:

1. Choosing the best design for a high-efficiency gas furnace

2. Selecting the most suitable robot for a welding operation on an automotive assembly line
3. Making a recommendation about whether jet airplanes for an overnight delivery service should be
purchased or leased
4. Considering the choice between reusable and disposable bottles for high-demand beverages

With items 1 and 2 in particular, note that coursework in engineering should provide sufficient means to
determine a good design for a furnace, or a suitable robot for an assembly line, but it is the economic
evaluation that allows the further definition of a best design or the most suitable robot.

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 ECO 017: Engineering Economics
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Name:_________________________________________________________ Class number: ______

Section: ____________ Schedule: ________________________________ Date: _______________

In item 1 of the list above, what is meant by " high-efficiency"? There are two kinds of efficiency that
engineers must be concerned with. The first is physical efficiency, which takes the form:
System output(s)
Economic (efficiency ) = -----------------
System input(s)

EARNING POWER OF MONEY

The earning power of money represents funds borrowed for the prospect of gain.

Often these funds will be exchanges for goods, services, or production tools, which in turn can be
employed to generate and economic gain

PURCHASING POWER OF MONEY

The prices of goods and services can go upward or downward, and therefore, the purchasing power of
money can change with time.

1. Price Reductions : Caused by increases in productivity and availability of goods.

2. Price Increases : Caused by government policies, price support schemes, and deficit financing.

ROLE OF UNCERTAINTY IN ENGINEERING

When conducting engineering economic analyses, it will be assumed at first, for simplicity, that benefits,
costs, and physical quantities will be known with a high degree of confidence. This degree of confidence is
sometimes called assumed certainty. In virtually all situations, however, there is some doubt as to the
ultimate values of various quantities. Both risk and uncertainty in decision-making activities are caused by a
lack of precise knowledge regarding future conditions, technological developments, synergies among funded
projects, etc. Decisions under risk are decisions in which the analyst models the decision problem in terms of
assumed possible future outcomes, or scenarios, whose probabilities of occurrence can be estimated. Of
course, this type of analysis requires an understanding of the field of probability. Decisions under uncertainty,
by contrast, are decision problems characterized by several unknown futures for which probabilities of
occurrence cannot be estimated. Other less objective means exist for the analysis of such problems.

For the purposes of this brief tutorial, we cannot delve further into the analytical extensions required to
accommodate risk or uncertainty in the decision process. We must recognize that these things exist,
however, and be careful about reaching strong conclusions based on data which might be susceptible to
these. Because engineering is concerned with actions to be taken in the future, an important part of the
engineering process is improving the certainty of decisions with respect to satisfying the objectives of
engineering applications.

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 ECO 017: Engineering Economics
Module #1 Student Activity Sheet

Name:_________________________________________________________ Class number: ______

Section: ____________ Schedule: ________________________________ Date: _______________

CLASSIFICATION OF COST

A key objective in engineering applications is the satisfaction of human needs, which will nearly always
imply a cost.

Economic analyses may be based on a number of cost classifications:

1. First (or Initial) Cost : Cost to get activity started such as property improvement,
transportation, installation, and initial expenditures.
2. Operation and Maintenance Cost : They are experienced continually over the usefull life of
the activity.
3. Fixed Cost : Fixed costs arise from making preparations for the future, and includes costs
associated with ongoing activities throughout the operational life-time of that concern. Fixed
costs are relatively constant; they are decoupled from the system input/output, for example.

SUPPLY AND DEMAND

1. Demand curve shows the number of units people are willing to buy and cost per unit (decreasing
curve).
2. Supply curve shows the number of units that vendors will offer for sale and unit price (increasing
curve).
3. The intersection defines the exchange price.
4. Elasticity of demand. Price changes and their effect on demand changes. It depends on whether the
consumer product is a necessity or a luxury.
5. Law of diminishing return. A process can be improved at a rate with a diminishing return. Example:
cost of inspection to reduce cost of repair and lost production.

Activity 3: Skill-building Activities

Let’s practice! After completing each exercise, you may refer to the Key to Corrections for feedback. Try to
complete each exercise before looking at the feedback.

YOU CAN
DO IT!

True or False
________1. Purchasing power is the value of a currency expressed in terms of the amount of goods or
services that one unit of money can buy. Purchasing power is important because, all else being equal.
4

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 ECO 017: Engineering Economics
Module #1 Student Activity Sheet

Name:_________________________________________________________ Class number: ______

Section: ____________ Schedule: ________________________________ Date: _______________

________2. Demand is the quality of certain commodity that is bought at a certain price at a given place and
time.
________3. Consumer goods and services are those products and services are directly consumed or use by
a consumer after its purchase and satisfy their wants

________4. Economic environments is due to economics being involved with the duty of the people and the
structure of organizations.

Activity 4: What I Learned

1. _________________________________________________________________________________
_________________________________________________________________________________

2. _________________________________________________________________________________
_________________________________________________________________________________

3. _________________________________________________________________________________
_________________________________________________________________________________

Activity 5: Check for Understanding

1. It is a subset of economics concerned with the use and application of economic principles in
the analysis of engineering decisions. As a discipline, it is focused on the branch of economics
known as microeconomics in that it studies the behavior of individuals and firms in making
decisions regarding the allocation of limited resources.

2. quantity of goods and services that can be bought with a monetary unit. Because of rising
prices, the purchasing power of currency deteriorates over time.

C.LESSON WRAP-UP

Activity 6: Thinking about Learning

A. Work Tracker
You are done with this session! Let’s track your progress. Shade the session number you just
completed.

Period 1 Period 2 Period 3

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17

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Name:_________________________________________________________ Class number: ______

Section: ____________ Schedule: ________________________________ Date: _______________

B. Think about your Learning

1. What motivated you to finish the lesson today?

2. What could you have done better to improve your learning today?

FAQs

1. What are the applications of engineering economics?

3.2. What are the importance of engineering economics?

GOOD
JOB FOR
FINISHING
THE TASK!

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 ECO 017: Engineering Economics
Module #2 Student Activity Sheet

Name:______________________________________________________________ Class number: _______

Section: ____________ Schedule: _______________________________________ Date: ________________

Lesson Title: SIMPLE INTEREST AND CASH Materials:

FLOW DIAGRAM Ballpoint and or highlighter
Learning Targets:
At the end of the module, you should be able to: References:
Define Simple Interest Engineering Economy by Hipolito
2. Give example in Simple Interest B. Sta. Maria, 3rd Ed
3. Solve problems in Simple Interest Engineering Mathematics vol 2 by
4. Define Cash Flow Diagram Gillesania

A. LESSON PREVIEW/REVIEW

Introduction

Interest can be viewed in two perspectives: the borrower’s perspective and the lender’s perspective. From the
borrower’s perspective, it is the fee paid on an amount of money, whether it's loaned or borrowed. On the
other hand, the lender considers the interest as the income earned with respect to the amount invested or
being borrowed by another entity (individual or a group).

Interest can affect you in various aspects of your financial life:

• When borrowing money: You must repay the amount you borrowed and make extra payments for
interest, which represents the cost of borrowing.
• When lending money: You typically set a rate and earn interest income in exchange for making your
money available to other people.
• When depositing money: Interest-bearing accounts, such as savings accounts, pay interest income
because you are making your money available to the bank to lend to others.

B. MAIN LESSON Activity 2: Content Notes

SIMPLE INTEREST

Simple Interest is calculated using the principal only. Ignoring any interest that had been accrued in
preceding periods. In practise, simple interest is paid on short-term loans in which the time of the loan is
measured in days.

Formula: where:
I = Pin I = Interest
F=P+I P = Principal of present worth
= P + Pin n = number of interest periods in years
F = P (1 + i) i = interest rate per interest period
F = Future worth

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Name:______________________________________________________________ Class number: _______

Section: ____________ Schedule: _______________________________________ Date: ________________

a) Ordinary simple interest is computed on the basis of one banker’s years which is 12 months of 30
days each or 360 days a year

b) Exact simple interest is based on the exact number of days in a year, 365 for an ordinary year and
366 days for a leap year

TERMINOLOGIES USED IN INTEREST

Principal: Also called Present worth, It is a term that has several financial meanings. The most
commonly used refers to the original sum of money borrowed in a loan or put into an
investment.

Future Worth: Is the accumulated value or amount of a current asset at a future date based on an
assumed rate of growth.

Interest: is the amount of money paid for the use of borrowed capital. For the lender, the interest is the
income produced by the money which he has lend

Example 1: Find the interest on P6,800.00 for 3 years at 11% simple interest.

*In solving a word problem take down the given and identify what is being asked in the
question
Given: P = P6,800
Required: I =?
i = 11% = 0.11
n = 3 years

Solution: I = Pin
I = P6,800(0.11)(3)
I = P2,244.00

Note: The unit for time is in years. Convert to years whenever the given is in month, days and etc.

Example 2: Determine the exact simple interest on P500 for the period from January 10 1996 to
December 31, 1997 at 16% interest

* first count the exact days occur from January 10 1996 to December 31 1997.
Solution:
January 10 - December 3, 1996 → 366 - 10 = 356 (1996 is leap year and January 1 to 10 is
excluded)
January 1 - December 31, 1997 → 365 = 1 year
Exact simple interest = 500(0.16)(1 + 356⁄366) = P157.82

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 ECO 017: Engineering Economics
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Name:______________________________________________________________ Class number: _______

Section: ____________ Schedule: _______________________________________ Date: ________________

CASH-FLOW DIAGRAM
A cash-flow diagram is simply a graphical representation of cash flow drawn on a time scale. Cash-
flow diagram for economic analysis problems is analogous to that of free body diagram for mechanics
problems. Cash flow diagrams helps to visualize and simplify problems having diverse receipts and
disbursements.

Convention Used in Cash flow Diagram:

• The horizontal (time) axis is marked off in equal increments, one per period, up to the duration or
horizon of the projects.
• All disbursement and receipts (cash-flow) are assumed to take place at the end of the year in which
they occur. This is known as the year-end convention. The exception of the year end convention is
the initial cost (purchase cost) which occur at t = 0
• Two or more transfers in the same period placed end-to-end may be combined into one
• Expenses incurred before t = 0 are called sunk cost and are not relevant to the problem
• Receipts and disbursement are represented by arrows on opposite side of the horizontal time axis.
Up arrow is receipt (positve cash flow or inflow), down arrow is disbursement (negative cash flow or
cash outflow)

Example: An electronic equipment cost P30,000. Maintenance cost is P3,000, each year. The device
will generate revenues of P15,000, each year for 5 years after which the salvage value is
expected to be P12,000.

The following shows the cash-flow diagram for each transaction.

The simplified cash flow is as follows.

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Name:______________________________________________________________ Class number: _______

Section: ____________ Schedule: _______________________________________ Date: ________________

Activity 3: Skill-building Activities

1. Eren borrowed P10,000 from his friend and agrees to

pay at the of 90 days under 8% simple interest rate. GOD BLESS
What is the future amount of the borrowed money?
2. How long must a P40,000 note bearing 4% simple
interest run to amount to P41,350.00?
3. Determine the exact simple interest on P1,000 for the
period from January 10 to December 31, 2012 at 12% interest rate.
4. What is the principal amount if the amount of interest
at the end of 2 1/2 year is P4,500 for a simple interest of 6% per year?
5. How long must a P40,000 note bearing 4% simple interest run to amount P41,350?

6. A student deposits P1,500 in the bank today. He deposits another P3,000 after two years, and he
withdraw an amount of P5,000 after five years. Determine the remaining balance in the stated student
account.

7. A machine cost P120,000, maintenance cost of P5,000 every two years. The device will generate
revenues of P25,000, each year for 6 years after which the salvage value is expected to be P20,000.
Construct the cashflow diagram/

8. A loan of P100 at simple interest of 10% will become P150 after years. Use borrower’s viewpoint to
construct the cashflow diagram.

Activity 4: What I Learned

1. _________________________________________________________________________________
_________________________________________________________________________________

2. _________________________________________________________________________________
_________________________________________________________________________________

3. _________________________________________________________________________________
_________________________________________________________________________________

Activity 5: Check for Understanding

1. Lucy Heartfillia buy a television set from a merchant who offers P25,000 at the end of 60 days. She
wishes to pay immediately and the merchant offers to compute the required amount on the
assumption that money is worth 14% simple interest. What is the required amount?

2. Determine the exact simple interest on P5,000 for the period of from Jan. 15 to Nov. 28 1992, if the
interest rate is 22%

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 ECO 017: Engineering Economics
Module #2 Student Activity Sheet

Name:______________________________________________________________ Class number: _______

Section: ____________ Schedule: _______________________________________ Date: ________________

3. A mixer cost P30,000. Maintenance cost is P3,000, every two years. The device will generate
revenues of 10,000, each year for 6 years after which the salvage value is expected to be
P5,000.make a cash-flow diagram of a mixer in 6 years period

C. LESSON WRAP-UP

Activity 6: Thinking about Learning

1. What motivated you to finish the lesson today?

________________________________________________________________________
________________________________________________________________________

2. What could you have done better to improve your learning today?
_________________________________________________________________________
_________________________________________________________________________

FAQs

1. How to solve exact simple interest dealing with a different total days of the year?
________________________________________________________________________
________________________________________________________________________

2. Example of outflow and inflow in cash flow diagram

________________________________________________________________________
________________________________________________________________________

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 ECO 017: Engineering Economics
Module #3 Student Activity Sheet

Name:______________________________________________________________ Class number: _______

Section: ____________ Schedule: _______________________________________ Date: ________________

Lesson Title: COMPOUND INTEREST Materials:

Learning Targets: Ballpoint and/or highlighter,
At the end of the module, you should be able to: calculator
1. Define compound interest
2. Solve problems involving compound Interest References:
3. Calculate effective rate of interest Engineering Economy by Hipolito
4. Use the concept of effective rate to find the equivalent rate for B. Sta. Maria, 3rd Ed
compound interest Engineering Mathematics vol 2 by
Gillesania
https://www.thebalance.com/comp
ound-interest
https://ecampusontario.pressbooks
.pub/businessmath/chapter/equival
ent-interest-rates/

A. LESSON PREVIEW/REVIEW

Introduction

Compound interest is an important concept to understand when managing your finances. It can help you earn
a higher return on your savings and investments, but it can also work against you when you're paying interest
on a loan.

Think about compound interest a bit like what happens when the "snowball effect" occurs. A snowball starts
small, but the more snow that's added, the bigger it gets. As it grows, it becomes bigger at a faster rate.

B. MAIN LESSON

Activity 2: Content Notes

COMPOUND INTEREST

In the compound interest, the interest rate is computed every end of period (compounding period),
and the interest earned for that period is added to the principal (interest plus principal).
To demonstrate this, consider an investment of P 1,000 to earn 10% per year for three years.
The following diagram shows how the money grows

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Section: ____________ Schedule: _______________________________________ Date: ________________

Formula: 𝑭 = 𝑷(𝟏 + 𝒊)𝒏

𝒊 = 𝒓/𝒎
𝒏 = 𝒕𝒎

Where: P = Present worth or Principal

F = Future worth
r = nominal interest rate (stated compounded interest)
t = number of years of that the money is saved, invested, or borrowed
n = total number of compounding periods
m = number of compounding periods per year
▪ m = 1, if compounding annually
▪ m = 2, if compound semi-annually
▪ m = 4, if compound quarterly
▪ m = 6, if compounded bimonthly
▪ m = 12, if compounded monthly

Example 1: The amount of P2,825.00 in 8 years at 5% compounded quarterly is?

[Hint: Always identify the given and required in the problem]

Given: 𝑃 = P 2825, 𝑟 = 0.05, 𝑚 = 4, 𝑡 = 8

Solution:
𝐹 = 𝑃(1 + 𝑖)𝑛
𝑭 = 𝑷(𝟏 + 𝒓/𝒎)𝒕𝒎
𝐹 = 2825(1 + 0.05/4)(8)(4)
𝑭 = P 𝟒, 𝟐𝟏𝟒. 𝟒

Example 2: Natsu is expecting to receive P 450,000 at the end of 15 years. If the money is worth 14%
compounded semi-annually, how much is its worth at present?

Given: 𝑃 = P 450,000, 𝑟 = 0.14, 𝑚 = 2, 𝑡 = 15

Solution:
𝑭 we are required to find the
𝐹 = 𝑃(1 + 𝑖)𝑛 −→ 𝑷 =
(𝟏 + 𝒊)𝒏 present worth so we must
𝒓 transpose the formula
𝒊 = 𝑎𝑛𝑑 𝒏 = 𝒕𝒎
𝒎
𝐹 450,000
𝑃= =
(1 + 𝑖)𝑛 0.14 (15)(2)
(1 + 2 )
𝑷 = P 𝟓𝟗, 𝟏𝟏𝟓. 𝟐𝟎

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 ECO 017: Engineering Economics
Module #3 Student Activity Sheet

Name:______________________________________________________________ Class number: _______

Section: ____________ Schedule: _______________________________________ Date: ________________

Example 3: A sum of P 10,000 is invested now with an interest rate is 13.5% compounded annually
and left for the eight years at which time the principal is withdrawn. Afterwards, the interest
that has accrued is left for another eight years. This time, the new interest rate is 15%
compounded bimonthly, what will be the withdrawal amount of at the end of 16 years.

Solution: This problem can be analyze using cash-flow diagram. As we analyze the diagram, we are
required to find the future amount of the investment at 16th year time period. First, we must
find the future amount of investment at the 8th year period and then subtract P 10,000 as
stated in the problem.

Given: For the 1st eight years

𝑃 = P 10,000, 𝑟 = 0.135, 𝑚 = 1, 𝑡 = 8

8
𝑭𝟖 = 𝑷(𝟏 + 𝒊)𝒏 = 10,000(1 + 0.135)

𝐹8 = P 27,540.19

𝑷𝟖 = 𝑭𝟖 − 𝑷 = 27,540.19 − 10,000
𝑷𝟖 = 𝑷 17,540.19 (total amount of interest accumulated for the first eight years)

Starting the 8th year,

𝑃8 = is also the remaining principal amount invested from 8th year up to the 16th year

Given: For the 2nd eight years (year 8 to 16)

n = is the total number of years remaining for 𝑃8 investment

n = 16 – 8 = 8
𝑟 = 0.05, 𝑚 = 6, 𝑡 = 8

Now we can compute the future amount of the investment 𝑷𝟖 from 8th year up to the 16th year
0.15 (8)(6)
𝐹16 = 𝑃8 (1 + 𝑖)𝑛 = 17,540.19 (1 + )
6

𝑭𝟏𝟔 = 𝑷 𝟓𝟕, 𝟑𝟖𝟐. 𝟓𝟓

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Name:______________________________________________________________ Class number: _______

Section: ____________ Schedule: _______________________________________ Date: ________________

EFFECTIVE RATE OF INTEREST

The effective rate of interest is the real return on a savings account or any interest-paying
investment when the effects of compounding over time are taken into account. It also reveals the real
percentage rate owed in interest on a loan, a credit card, or any other debt.

It is also called the effective annual interest rate, the effective rate or the annual equivalent
effective rate.

The Formula for Effective Annual Interest Rate Is

𝒓 𝒎
Effective Rate of Interest, 𝑬𝑹𝑰 = (𝟏 + ) − 𝟏
𝒎
where:
m = number of compounding periods per year
r = stated interest or given compounded interest

Example 4: consider these two offers: Investment A pays 10% interest, compounded monthly. Investment
B pays 10.1% compounded semi-annually. Which is the better offer?
Solution:
In both cases, the advertised interest rate is the nominal interest rate. The effective annual interest rate
is calculated by adjusting the nominal interest rate for the number of compounding periods the financial
product will experience in a period of time. In this case, that period is one year. The formula and
calculations are as follows:

For investment A, For Investment B

𝒓 𝒎
𝐸𝑅𝐼 = (𝟏 + 𝒎
) −𝟏
𝒓 𝒎 𝒓 𝒎
𝐸𝑅𝐼𝐴 = (𝟏 + 𝒎
) −𝟏 𝐸𝑅𝐼𝐵 = (𝟏 + 𝒎) − 𝟏

𝟎.𝟏𝟎 𝟏𝟐 𝟎.𝟏𝟎𝟏 𝟐
𝐸𝑅𝐼𝐴 = (𝟏 + 𝟏𝟐
) −𝟏 𝐸𝑅𝐼𝐵 = (𝟏 + 𝟐
) −𝟏
𝐸𝑅𝐼𝐴 = 𝟎. 𝟏𝟎𝟒𝟕 𝒐𝒓 𝟏𝟎. 𝟒𝟕% 𝐸𝑅𝐼𝐵 = 𝟎. 𝟏𝟎𝟑𝟔 𝒐𝒓 𝟏𝟎. 𝟑𝟔%

Hence, Investment A has a better offer for it has greater ERI.

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Section: ____________ Schedule: _______________________________________ Date: ________________

EQUIVALENT RATE OF INTEREST

Equivalent interest rates are interest rates that produce the same future worth of a certain amount after
one year.
For example, 10% compounded quarterly and 10.125% compounded semi-annually are equivalent
nominal interest rates. If you calculate the future value of $100 invested at either rate for one year, you
will obtain $110.38.

You can see that equivalent interest rates have different numerical values but produce the same effect.

The term “equivalent rates” carries with it the same concept as “effective rates” but takes into account
interest rates that are compounded more than once per year. Note that “effective rates” refer to interest
rates that are compounded annually.

Example 5: Find the equivalent annual interest rate of an effective rate of 8% compounded quarterly.
𝒓 𝒎
𝐸𝑅𝐼 = (𝟏 + 𝒎) − 𝟏

Solution: [Hint: Use the concept of ERI. Also, if you have a nominal interest rate of 10% compounded
annually, then the Annual Equivalent Rate is the same as 10%, 𝑖 = 𝑟.]

𝒓 𝒎
𝐸𝑅𝐼 = (𝟏 + 𝒎) − 𝟏
Compounded Annually Compounded Quarterly
𝒎𝑨 𝒎𝑸
𝒓 𝒓
𝐸𝑅𝐼𝐴 = (𝟏 + 𝒎𝑨 ) −𝟏 𝐸𝑅𝐼𝑄 = (𝟏 + 𝒎𝑸 ) −𝟏
𝑨 𝑸

𝒓 𝟏 𝟎.𝟎𝟖 𝟒
𝐸𝑅𝐼𝐴 = (𝟏 + 𝟏𝑨 ) − 𝟏 𝐸𝑅𝐼𝑄 = (𝟏 + ) −𝟏
𝟒
𝐸𝑅𝐼𝐴 = 𝐸𝑅𝐼𝑄

𝟎. 𝟎𝟖 𝟒
(𝟏 + 𝒓𝑨 ) − 1 = (𝟏 + ) −𝟏
𝟒
0.08 4
(1 + 𝑟𝐴 ) = (1 + )
4
1 + 𝑟𝐴 = 1.0824
𝒓𝑨 = 𝟎. 𝟎𝟖𝟐𝟒 𝒐𝒓 𝟖. 𝟐𝟒%

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Example 6: Find the equivalent rate of interest compounded monthly of 8% compounded quarterly.

Solution:
In finding the equivalent rate we must remember that they have the same effective rate which
produce the same amount of future worth.

𝒓 𝒎
𝐸𝑅𝐼 = (𝟏 + 𝒎) − 𝟏
Compounded Monthly Compounded Quarterly
𝒎𝑸
𝒓𝑴 𝒎𝑴 𝒓
𝐸𝑅𝐼𝑀 = (𝟏 + 𝒎 ) −𝟏 𝐸𝑅𝐼𝑄 = (𝟏 + 𝒎𝑸 ) −𝟏
𝑴 𝑸

𝒓 𝟏𝟐 𝟎.𝟎𝟖 𝟒
𝑴
𝐸𝑅𝐼𝐴 = (𝟏 + 𝟏𝟐 ) −𝟏 𝐸𝑅𝐼𝑄 = (𝟏 + 𝟒
) −𝟏
𝐸𝑅𝐼𝑀 = 𝐸𝑅𝐼𝑄
𝒓𝑴 𝟏𝟐 𝟎. 𝟎𝟖 𝟒
(𝟏 + ) − 1 = (𝟏 + ) −𝟏
𝟏𝟐 𝟒
𝒓𝑴 𝟏𝟐 0.08 4
(𝟏 + ) = (1 + )
𝟏𝟐 4
𝒓𝑴 𝟏𝟐
(𝟏 + ) = 1.0824
𝟏𝟐
𝑟𝑀 12 1
1+ = √1.0824 = 1.0824 12
12
𝑟𝑀 1
= 1.0824 12 − 1
12
𝒓𝑴 = 𝟎. 𝟎𝟕𝟗𝟒𝟒 𝒐𝒓 𝟕. 𝟗𝟒%

Activity 3: Skill-building Activities

1. If the interest rate on an account is 11.5% compounded yearly, approximately how many years
will it take to triple the amount
2. Shoyo Hinata lends P6,000 at 6% simple interest for 4 years. At the end of this time, he invests
the entire amount (principal plus interest) at 5% compounded annually for 12 years. How much
will he have at the end of the 16 years period?
3. Fairytail firm borrows P200,000 for 6 years at 8%. At the end of 6 years, it renews the loan for the
amount due plus P2,000 more for 2 years at 8%. What is the lump sum due?
4. At a certain interest rate compounded semi-annually, P5,000 will amount to P20,000 after 10
years. What is the amount at the end of 15 years?

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5. Compute the interest for an amount of P200,000 for a period of 8 years if was made at 16%
compounded every 2 months? I = F – P
6. Find the equivalent rate of 6% compounded semi-annually in a compounded quarterly.
7. Which has the least effective rate of interest
a. 11% compounded monthly
b. 11.2 % compounded quarterly
8. Find the annual effective rate of 16% compounded quarterly?

Activity 4: What I Learned

1. _________________________________________________________________________________
_________________________________________________________________________________

2. _________________________________________________________________________________
_________________________________________________________________________________

3. _________________________________________________________________________________
_________________________________________________________________________________

Activity 5: Check for Understanding

1. Grisha Yeager 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 first five years and 12%
compounded quarterly during the next five years.

2. P500,000 was deposited 20.15 years ago at an interest of 7% compounded semi-annually. How
much is the sum now?

3. By the condition of a will, the sum of P25,000 is left to a girl to be held her guardian until it
amounts to P45,000. When will the girl receive the money if the fund is invested at 8%
compounded quarterly?

4. Find the nominal rate of 22% compounded every 3 months

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C. LESSON WRAP-UP

Activity 6: Thinking about Learning

.
1. What motivated you to finish the lesson today?
________________________________________________________________________
________________________________________________________________________

2. What could you have done better to improve your learning today?
_________________________________________________________________________
_________________________________________________________________________

FAQs

1. What is compounding period?

________________________________________________________________________
________________________________________________________________________

2. Why borrowing money is a good idea?

________________________________________________________________________
________________________________________________________________________

KEY TO CORRECTIONS (refer to TG’s)

Activity 3

1. 10 years
2. P 13,361.2
3. P 6034.66
4. P 40,029.72
5. P 507,367.94
6. 5.96%
7. a. 11.57%
b. 11.68% - least
5. 16.99%

ATTACH ADDITIONAL SHEETS OF PAPER

FOR YOUR SOLUTIONS!

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Name:______________________________________________________________ Class number: _______

Section: ____________ Schedule: _______________________________________ Date: ________________

Lesson Title: CONTINUOUS COMPOUNDING Materials:

Learning Targets: Ballpoint and or highlighter
At the end of the module, you should be able to: Text book: Engineering Economy
1. Define Continuous compounding by Hipolito B. Sta. Maria,
2. Solve problems related to continuous compounding 3rd Ed
References:
1. Engineering Mathematics vol 2
by Gillesania
2. www.analyzemath.com/finance/in
terests_p roblems_sol.html
3. https://corporatefinanceinstitute.c
om/resources/knowledge/finance/
continuously-compounded-
interest/

A. LESSON PREVIEW/REVIEW

Continuously compounded interest is interest that is computed on the initial principal, as well as all interest
other interest earned. The idea is that the principal will receive interest at all points in time, rather than in a
discrete way at certain points in time.
The continuous payment of interest leads to exponential growth and is many times used as an argument
for wealth creation. Albert Einstein is credited with the phrase “compound interest is the most powerful force in
the universe.” While it is undetermined if he actually said it, it says a lot about the importance of the concept.

B. MAIN LESSON

Activity 2: Content Notes

CONTINUOUS COMPOUNDING

Continuous compounding is the mathematical limit that compound interest can reach if it's calculated
and reinvested into an account's balance over a theoretically infinite number of periods. While this is not
possible in practice. It is an extreme case of compounding, as most interest is compounded on a monthly,
quarterly, or semi-annual basis.
Instead of calculating interest on a finite number of periods, such as yearly or monthly, continuous
compounding calculates interest assuming constant compounding over an infinite number of periods. The
formula for compound interest over finite periods of time takes into account four variables:
From the formula of compound interest, 𝑭 = 𝑷(𝟏 + 𝒊)𝒏 . we know that 𝑖 = 𝑟/𝑚 and 𝑛 = 𝑡𝑚 . In
continuous compounding we assume an infinite number of compounding.
𝐹 = 𝑃 (1 + 𝑟/𝑛)𝑛𝑡

Here, n = the number of terms the initial amount (P) is compounding in the time t and F is the final amount
(or) future value. For the continuous compound interest, n → ∞.

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So, we will take the limit of the above formula as n → ∞.

𝐹 = 𝑙𝑖𝑚𝑛→∞ 𝑃 (1 + 𝑟/𝑛)𝑛𝑡

The final step is by using one of the limit formulas which says, 𝑙𝑖𝑚𝑛→∞ (1 + 𝑟/𝑛)𝑛 = 𝒆𝒓

Thus, the continuous compound interest formula is,

𝐹 = 𝑷𝒆𝒓𝒕
where 𝒆 is the mathematical constant approximated as 2.7183.

KEY TAKEAWAYS

• Most interest is compounded on a semiannually, quarterly, or monthly basis.

• Continuously compounded interest assumes interest is compounded and
added back into the balance an infinite number of times.
• The formula to compute continuously compounded interest takes into
account four variables.
• The concept of continuously compounded interest is important even though it’s
not possible in practice.

Example 1: If you invest P10,000 at an annual interest rate of 5% compounded continuously, calculate
the final amount you will have in the account after five years.

Solution: 𝑭 = 𝑷𝒆𝒓𝒕 = 10,000 e(.05)(5)

𝑭 = P 12,840.25

Example 2: How long will it take money to triple if it earns 7% per annum compounded continously?
rt
Solution: F=Pe
0.07t
3P = P e

3 = e0.07t Use the natural logarithm to eliminate

the exponent
ln3 = 0.07t (ln e) where: ln e = 1
ln3 = 0.07t
t = 15.69 years

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Activity 3: Skill-building Activities

SOLVE THE FOLLOWING PROBLEMS.

1. An amount of P2,340.00 is deposited in a bank paying an annual

interest rate of 3.1%, compounded continuously. Find the
balance after 3 years.

2. P12,00 is placed in an account at 4% compounded annually for 2

years. It is then withdrawn at the end of the two years and placed in another bank at the rate
of 5% compounded annually for 4 years. What is the balance in the second account after the 4
years.

3. What principal you have to deposit in a 4.5% saving account compounded continuously in
order to have a total of P10,000 after 8 years?
4. What interest rate, compounded continously, is needed for a principal of P4,000 to increase to
P13,000 in 10 year?

Activity 4: What I Learned

1. _________________________________________________________________________________
_________________________________________________________________________________

2. _________________________________________________________________________________
_________________________________________________________________________________

3. _________________________________________________________________________________
_______________________________________________________________________________

Activity 5: Check for Understanding

1. A person deposited P1,000 in a 2% account compounded continuously. In a second account, he

deposited P500 in a 8% account compounded continuously. When will the total amounts in both
accounts be equal? When will the total amount in the second accounts be 50% more than the total
amount in the second account?

2. An amount of $1,500 is invested for 5 years at the rates of 2% for the first two years, 5% for the
third year and 6% for the fourth and fifth years all compounded continuously. What is the total
amount at the end of the 5 years?

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Name:______________________________________________________________ Class number: _______

Section: ____________ Schedule: _______________________________________ Date: ________________

6. LESSON WRAP-UP

Activity 6: Thinking about Learning

1. What motivated you to finish the lesson today?

________________________________________________________________________
________________________________________________________________________

2. What could you have done better to improve your learning today?
_________________________________________________________________________
_________________________________________________________________________

FAQs

1. Why continuous compounding is important?

________________________________________________________________________
________________________________________________________________________

2. The more number compounding period procuces more interest?

________________________________________________________________________
________________________________________________________________________

KEY TO CORRECTIONS Keep moving

forward
Activity 3
1. P2,568.06
2. P15,776.3
3. P6,976.76
4. 11.79%

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Name:______________________________________________________________ Class number: _______

Section: ____________ Schedule: _______________________________________ Date: _______________

Lesson Title: DISCOUNT AND INFLATION Materials:

Learning Targets: Ballpoint and or highlighter, Notebook, Calculator
At the end of the module, you should be able to:
Define Inflation References:
2. Give example of inflation Engineering Economy by Hipolito B. Sta. Maria, 3rd Ed
3. Solve problems in inflation Engineering Mathematics vol 2 by Gillesania
https://www.investopedia.com/terms/d/discountrate.asp

A. LESSON PREVIEW/REVIEW
In a world with inflation, the interest rate must cover both inflation and the cost of capital. Because the
true profitability of an investment is determined by the amount earned over inflation, it is very important for
you to be able to account for inflation when doing a financial analysis.
Inflation is the rate at which prices for goods and services increase. At first, this sounds like a simple
concept, but in actuality it is rather complex. Inflation affects numerous aspects of the market and many
factors influence it. If prices go up, the current value of the currency is eroded. What could have been
purchased a year prior for Php 1.00 might now cost Php 1.03, and if salaries had not risen in tandem with
this inflation, the public would have lost purchasing power.
From this vantage point, some may see inflation as a bad thing. However, the right balance of inflation
and economic growth is important for a healthy economy. An economy that grows too fast can cause high
rates of inflation and an economy with slow or no growth can cause low levels of inflation or even deflation
(when prices decline).
The discount rate is the rate at which society as a whole is willing to trade off present for future benefits.
When weighing the decision to undertake a project with long-term benefits versus one with short-term benefits
and long-term costs, the discount rate plays an extremely important role in determining the outcome of the
analysis. Indeed, a number of reasonable decision measures (e.g., net present value, benefit-cost ratio, return
on investment) depend critically on the chosen discount rate.
Why are discount rates needed? Because a peso received today is considered more valuable than one
received in the future.
There are four primary reasons for applying a positive discount rate.
1. positive rates of inflation diminish the purchasing power of dollars over time.
2. dollars can be invested today, earning a positive rate of return.
3. there is uncertainty surrounding the ability to obtain promised future income
4. humans are generally impatient and prefer instant gratification to waiting for long-term benefits.
Discount rates are used to compress a stream of future benefits and costs into a single present value
amount. Thus, present value is the value today of a stream of payments, receipts, or costs occurring over time,
as discounted through the use of an interest rate. Present value calculations of benefits and costs are then
compared to determine benefit-cost ratios.

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Section: ____________ Schedule: _______________________________________ Date: _______________

B. MAIN LESSON
Activity 2: Content Notes

DISCOUNT

A discount occurs when a transaction requires that interest be paid in advance, usually at the
start of the interest period. Discount on a negotiable paper is the difference between what it is worth in
the future and its present worth (the amount recived for the paper in cash) thus,

Discount (d)= Future Value – Present Value

The rate of discount is the discount on one unit of principal for one unit of time

𝒅 𝒊
𝒊= 𝑜𝑟 𝒅 =
𝟏−𝒅 𝟏+𝒊
where 𝒅 = 𝑟𝑎𝑡𝑒 𝑜𝑓 𝑑𝑖𝑠𝑐𝑜𝑢𝑛𝑡 𝑓𝑜𝑟 𝑡ℎ𝑒 𝑝𝑒𝑟𝑖𝑜𝑑 𝑖𝑛𝑣𝑜𝑙𝑣𝑒
𝒊 = 𝑟𝑎𝑡𝑒 𝑜𝑓 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑓𝑜𝑟 𝑡ℎ𝑒 𝑠𝑎𝑚𝑒 𝑝𝑒𝑟𝑖𝑜𝑑

Example 1: Zenitsu borrowed P5,000 from a bank and agreed to pay the loan at the end of 9 months.
The bank discounted the loan and gave him P4,0000 in cash. (a) What was the rate of
discount? (b) What was the rate of interest at the same time? (c) What was the equivalent
actual rate of interest for one year based on the actual borrowed money.

Solution:

(a) we are required to determine the discount but we can’t use our formula for we don’t have the value for
the interest. In this case, we will use discount is equal to amount of discount over principal amount
𝒂𝒎𝒐𝒖𝒏𝒕 𝒐𝒇 𝒅𝒊𝒔𝒄𝒐𝒖𝒏𝒕
𝒅=
𝒑𝒓𝒊𝒏𝒄𝒊𝒑𝒂𝒍 𝒂𝒎𝒐𝒖𝒏𝒕
1,000
𝒅= = 0.20 𝑜𝑟 20%
5,000

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(b) Interest rate

𝒅
𝒊=
𝟏−𝒅
0.20
𝒊= = 𝟎. 𝟐𝟓 𝒐𝒓 𝟐𝟓%
1 − 0.20

(c) Total Interest paid in advance I = P 1,000 assumed for the entire year.
𝑰 = 𝑷𝒊𝒏
𝑰
𝒊=
𝑷𝒏
1,000
𝒊= = 𝟎. 𝟑𝟑𝟑𝟑 𝒐𝒓 𝟑𝟑. 𝟑𝟑%
9
4, 000 ( )
12

Example 2: Mr. J. de la Cruz borrowed money from a bank. He received from the bank P1, 342 and
promises to repay P1, 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.”

Given: Required:
Actual Amount Received = P 1,342 d = rate of discount
Principal = P 1,500 i = rate of interest

Solution:
Amount of Discount (or simply Discount) = P 1,500- 1342 = 158

𝒂𝒎𝒐𝒖𝒏𝒕 𝒐𝒇 𝒅𝒊𝒔𝒄𝒐𝒖𝒏𝒕
𝒅=
𝒑𝒓𝒊𝒏𝒄𝒊𝒑𝒂𝒍 𝒂𝒎𝒐𝒖𝒏𝒕
158
𝒅= = 0.1053 𝑜𝑟 10.53%
1,500

Then,
𝒅
𝒊=
𝟏−𝒅
0.1053
𝒊= = 𝟎. 𝟏𝟏𝟕𝟕 𝒐𝒓 𝟏𝟏. 𝟕𝟕%
1 − 0.1053

Example 3: The tag price of a certain commodity is payable in 100 days but if paid in 30 days there will
be a 3% discount. Find the annual rate of interest

Solution: Analyze the problem using cash flow diagram

i= I = 0.03
Pn 100 -30
0.97( )
360
= 0.1591 = 15.91%

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Section: ____________ Schedule: _______________________________________ Date: _______________

INFLATION

Inflation is the rate at which the general level of prices and goods and services is increasing from
one year to another and subsequently, purchasing power of money is decreasing.
𝑭𝑪 = 𝑷𝑪(𝟏 + 𝒇)𝒏
Where: PC = present cost of commodity
FC = future cost of the same commodity
f = annual inflation rate
n = number of days

Example: An item presently costs P1,000. If inflation is at the rate of 8% per year, what will be the cost of the
item in two years?

Solution: 𝑭𝑪 = 𝑷𝑪(𝟏 + 𝒇)𝒏

𝐹𝐶 = 1,000(1 + 0.08)2
𝑭𝑪 = P 1,166.40

In an inflationary economy, the buying power of money decreases as costs increase thus,
𝑭 𝑷𝑪 𝟏
= =
𝑷 𝑭𝑪 (𝟏 + 𝒇)𝒏

𝐹 1
𝑜𝑟 𝑠𝑖𝑚𝑝𝑙𝑦, =
𝑃 (1 + 𝑓)𝑛

𝑷
𝑭=
(𝟏 + 𝒇)𝒏

Where: 𝑭 = Future worth (measured in today’s pesos of present amount P).

Example: An economy is experiencing inflation at annual rate of 8%. If this continues, what will P1,000 be
worth two years from now, in todays’ peso?
Solution:
𝑷
𝑭=
(𝟏 + 𝒇)𝒏
1,000
𝐹=
(1 + 0.08)2
𝑭 = P 857.34
Interpretation:

P1,000 in two years will be worth P 857.34 in terms of today’s peso. Stated the other way around,
in two years P1,000 will be required to purchase the same item or commodity that can now be
bought for P 857.34

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Section: ____________ Schedule: _______________________________________ Date: _______________

Activity 3: Skill-building Activities

SOLVE FOR THE FOLLOWING DISCOUNT PROBLEM

1. Engr. Hanamichi promised to pay P36,000 at the end of 90 days. He was

offered a 10% discount if he pays in 30 days. Find the rate of interest.

2. Krei is required to pay P57,000 in 15 days or P60,000 in 60 days. Find the

annual rate of interest

3. Find the present worth of P1,000 today (2021) in the year 1990 if the inflation rate of 12% is
constant through the years

4. If you invest P10,000 with a rate of interest of 12% compounded annually, compute the interest
of your investment after 10 years if the inflation rate is 10% annually.

5. A certain commodity has a present value of P15,000, find the future amount of the commodity after
3 years if the economic experiencing an inflation rate of 10% annually.

Activity 4: What I Learned

1. _________________________________________________________________________________
_________________________________________________________________________________

2. _________________________________________________________________________________
_________________________________________________________________________________

3. _________________________________________________________________________________
_________________________________________________________________________________

Activity 5: Check for Understanding

1. Taki deposits P50,000 in a bank account at 6% compounded monthly for 5 years. If the inflation rate
is 6.5% per year continues for this period. Will this effectively protect the purchasing power of the
original principal?

2. Mrs. Shimizu borrowed money from a bank. She received from the bank P1,342 and promised to
repay P1,500 at the end of 10 months. Determine (a) simple interest rate (b) discount offered as
Banker’s discount.
a. 14.13%
b. 10.53%

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C.LESSON WRAP-UP

Activity 6: Thinking about Learning

1. What motivated you to finish the lesson today?

________________________________________________________________________
________________________________________________________________________
2. What could you have done better to improve your learning today?
_________________________________________________________________________
_________________________________________________________________________

FAQs

1. Is investing in the bank is advisable? why?

________________________________________________________________________
________________________________________________________________________

2. What happen if you keep your money for long period of time?
________________________________________________________________________
________________________________________________________________________

KEY TO CORRECTIONS

Activity 3 DID YOU GET THE

CORRECT ANSWERS?

1. 66.67%
2. 34.78%
3. P33,555.11
4. P1,974.39
5. P19,965

ATTACH ADDITIONAL SHEETS OF PAPER FOR YOUR

SOLUTIONS!

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Lesson Title: ANNUITIES (ORDINARY ANNUITY) Materials: Ballpoint, Notebook,

Learning Targets: Calculator
At the end of the lesson, you should be able to:
1. Define the concept of annuity References:
2. Solve problems using the concept of ordinary annuities Engineering Economy by Hipolito
B. Sta. Maria, 3rd Ed

Engineering Mathematics vol 2 by

Gillesania

A. LESSON PREVIEW/REVIEW

Introduction

An annuity is a type of investment in which regular payments are made over the course of multiple periods.

Key Points

• Annuities have payments of a fixed size paid at regular intervals.

• Annuities help both the creditor and debtor have predictable cash flows, and it spreads
payments of the investment out over time.

B. MAIN LESSON

Content Notes

ANNUITY

An annuity is a series of equal payments made at equal intervals of time. Financial activities like
installment payments, monthly rentals, life-insurance premium, monthly retirement benefits, are familiar
examples of annuity.

Annuity can be certain or uncertain. In annuity certain, the specific amount of payments are set to
begin and end at a specific length of time. A good example of annuity certain is the monthly payments of a
car loan where the amount and number of payments are known. In annuity uncertain, the annuitant may be
paid according to certain event. Example of annuity uncertain is life and accident insurance. In this example,
the start of payment is not known and the amount of payment is dependent to which event.

Annuity certain can be classified into two, simple annuity and general annuity. In simple annuity, the
payment period is the same as the interest period, which means that if the payment is made monthly the
conversion of money also occurs monthly. In general annuity, the payment period is not the same as the

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interest period. There are many situations where the payment for example is made quarterly but the money
compounds in another period, say monthly. To deal with general annuity, we can convert it to simple annuity
by making the payment period the same as the compounding period by the concept
of effective rates.

ELEMENTS OF ANNUITY

A = amount of periodic payment

P = present amount of all periodic payments
F = future worth of all periodic payments after the last payment is made i
= interest rate per compounding period
n = total number of payments
m = nominal rate (see compounded interest)
t = number of years

CLASIFICATION OF ANNUITY

Simple annuity - Payment period is the same as the interest period. If the payment is made
monthly then the conversion of money also occurs monthly]
General annuity - Payment period is not the same as the interest period however it can be
converted to simple annuity by making the payment period is the same as the
compounding period by concepts of effective rates

TYPES OF ANNUITY

⚫ Ordinary Annuity
⚫ Deferred Annuity
⚫ Annuity Due
⚫ Perpetuity

ORDINARY ANNUITY

In ordinary annuity, the payment is made at the end of each period starting from the first period as
in the diagram below.

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Characteristics of Ordinary Annuity

A - annul equivalent value, occurs at the end of each period
F - future equivalent value, occurs at the same time as the last A and n intervals after P
P - present equivalent value, occurs one interest period before the first A (uniform amount)

Formulas:
𝒊
𝑨 = 𝑭[ ]
(𝟏 + 𝒊)𝒏 − 𝟏

(𝟏 + 𝒊)𝒏 − 𝟏
𝑭 = 𝑨[ ]
𝒊

(1+𝑖)𝑛 −1
Also, from 𝐹 = 𝑃(1 + 𝑖)𝑛 and 𝐹 = 𝐴[ 𝑖
]

(1 + 𝑖)𝑛 − 1
𝐴[ ] = 𝑃(1 + 𝑖)𝑛
𝑖

(𝟏 + 𝒊)𝒏 − 𝟏
𝑷 = 𝑨[ ]
𝒊(𝟏 + 𝒊)𝒏

Remember that the exponent n in the numerator is the number of payment that has made and the exponent
in the denominator is the number of period from F to P

Example 1: What is the present worth of P 10,000 at the end of every three months for 5 years if the
interest rate is 12% compounded quarterly?
Given:

𝐴 = P 10,000 𝑟 = 0.12 𝑚=4 𝑡 = 5 𝑦𝑒𝑎𝑟𝑠

In ordinary annuity, the number of payments is equal to number of periods n periods

Solution:
𝒓 𝟎.𝟏𝟐
with [𝒊 = = = 𝟎. 𝟎𝟑] and [𝒏 = 𝒕𝒎 = 𝟓(𝟒) = 𝟐𝟎]
𝒎 𝟒

(𝟏 + 𝒊)𝒏 − 𝟏
𝑷 = 𝑨[ ]
𝒊(𝟏 + 𝒊)𝒏

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(1 + 0.03)20 − 1
𝑷 = 10,000 [ ]
𝑖(1 + 0.03)20

𝑷 = P 𝟏𝟒𝟖, 𝟕𝟕𝟒. 𝟕𝟓

Example 2: If money is worth 10% compounded quarterly, what monthly savings is required monthly in order to
have P200,000 at the end at the end of 10 years

Given:

𝐹 = P 200,000 𝑡 = 10 𝑦𝑒𝑎𝑟𝑠

𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑡𝑒𝑟𝑚𝑠 (𝑞𝑢𝑎𝑟𝑡𝑒𝑟𝑙𝑦): 𝑟 = 𝒓𝑸 = 0.10 𝑚 = 𝒎𝑸 = 4

𝑃𝑎𝑦𝑚𝑒𝑛𝑡 𝑡𝑒𝑟𝑚𝑠 (𝑚𝑜𝑛𝑡ℎ𝑙𝑦) ∶ 𝑟 = 𝒓𝑴 𝑚 = 𝒎𝒎 = 12

Solution:
Analysis: The example problem is a general annuity where the payment period is not the same to the
interest period, so we must find the equivalent interest rate of compounded quarterly to compounded
monthly.

Compounded Monthly Compounded Quarterly

𝒎𝑴 𝒎𝑸
𝒓 𝒓
𝐸𝑅𝐼𝑀 = (𝟏 + 𝒎𝑴 ) −𝟏 𝐸𝑅𝐼𝑄 = (𝟏 + 𝒎𝑸 ) −𝟏
𝑴 𝑸

𝒓 𝟏𝟐 𝟎.𝟏𝟎 𝟒
𝑴
𝐸𝑅𝐼𝐴 = (𝟏 + 𝟏𝟐 ) −𝟏 𝐸𝑅𝐼𝑄 = (𝟏 + 𝟒
) −𝟏
𝐸𝑅𝐼𝑀 = 𝐸𝑅𝐼𝑄
𝒓𝑴 𝟏𝟐 𝟎. 𝟏𝟎 𝟒
(𝟏 + ) − 1 = (𝟏 + ) −𝟏
𝟏𝟐 𝟒
𝒓𝑴 𝟏𝟐 0.10 4
(𝟏 + ) = (1 + )
𝟏𝟐 4
𝒓𝑴 𝟏𝟐
(𝟏 + ) = 1.1038
𝟏𝟐
𝑟𝑀 12 1
1+ = √1.1038 = 1.1038 12
12
𝑟𝑀 1
= 1.1038 12 − 1
12
𝒓𝑴 = 𝟎. 𝟎𝟗𝟗𝟐 𝒐𝒓 𝟗. 𝟗𝟐%
𝒓𝑴
So, 𝒊𝑴 = 𝒎 = 𝟎. 𝟎𝟎𝟖𝟐𝟔
𝑴

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Now, we can have the equivalence in the number of payments and the number of interest periods as for the
use of ordinary annuity.

[𝒏 = 𝒕𝒎 = 𝟏𝟎(𝟏𝟐) = 𝟏𝟐𝟎]
𝒊
𝑨 = 𝑭[ ]
(𝟏 + 𝒊)𝒏 − 𝟏

0.00826
𝐴 = 200,000 [ ]
(1 + 0.00826)120 − 1

𝑨 = 𝑷 𝟗𝟖𝟏. 𝟐𝟖

Example 3: An engineer wants to start a business which requires purchase of a 𝑷 100,000 worth
machine which will produce a net income of 𝑷 11,000 per year after deducting operating
expenses. The engineer plans to put the machine on sale after 4 years. What must be the
resale price to justify the investment if the engineer should make 12% annual return on the
investment.

Solution: [Hint: Create a cash flow-diagram for this problem to facilitate analysis]

𝑃11𝑘 𝑃11𝑘 𝑃11𝑘 𝑃11𝑘

𝑃100𝑘 𝑅𝑒𝑠𝑎𝑙𝑒 𝑃𝑟𝑖𝑐𝑒

𝑅𝑃

𝐹𝐴

𝑃11𝑘 𝑃11𝑘 𝑃11𝑘 𝑃11𝑘

1 2 3 4
𝐹𝑃𝑂
𝑃100𝑘

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Analysis: To solve the given problem, we must compute first for all future amount of annuity and of
machine at 4th year, then we have inflow equal to outflow
𝑅𝑃 + 𝐹𝐴 = 𝐹𝑃0
𝑅𝑃 = 𝑅𝑒𝑠𝑎𝑙𝑒 𝑃𝑟𝑖𝑐𝑒
𝐹𝐴 = 𝑓𝑢𝑡𝑢𝑟𝑒 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑎𝑛𝑛𝑢𝑖𝑡𝑦 𝑝𝑎𝑦𝑚𝑒𝑛𝑡 𝑃 11𝑘
𝐹𝑃𝑂 = 𝑓𝑢𝑡𝑢𝑟𝑒 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑝𝑢𝑟𝑐ℎ𝑎𝑠𝑒 𝑜𝑟𝑑𝑒𝑟 𝑃 100𝑘

𝐹𝐴 =P11,000[(1+ 0.12)4 -1]= P52,572.61

𝐹𝑃𝑂 = P100,000(1+0.12)4 = P157,351.94

FRS = P157,351.94 - P52,572.61

𝑅𝑒𝑠𝑎𝑙𝑒 𝑃𝑟𝑖𝑐𝑒 , 𝑹𝑷 = 𝑷 𝟏𝟎𝟒, 𝟕𝟕𝟗. 𝟑𝟑

Activity: Skill-building Activities

SOLVE FOR THE FOLLOWING PROBLEM

1. A contractor bought a concrete mixer at 𝑷 120,000 if paid in cash. The

mixer may also be purchased by installment to be paid within 5 years.
If money is worth 8% compounded annually, what is the amount of
each annual payments made at the end of each year if paid in
installment up to the end of 5 years?

2. How much money you must invest today in order to withdraw 𝑷 1,000
per year for 10 years, if the interest rate is 12%?

3. A service car whose cash price was 𝑷 540,000 was bought with a down payment of 𝑷 162,000 and
monthly of 𝑷 10,874.29 for five years. What was the rate of interest compounded monthly?

Activity: Check for Understanding

1. Mitsuha inherited regular endowment of 𝑷 100,000 every end of 3 months for 10 years. However,
she may choose to get a single lump sum if the end of 4 years. How much is this lump sum if the
cost of money is 14% compounded quarterly?

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2. A corporation will make the following disbursements:

a. 𝑷 50, 000 on December 31, 1991
b. 𝑷 100,000 on December 31, 1992
c. 𝑷 200,000 on December 31, 1993

To accumulate these sums, an ordinary annuity is established by making equal year-end

deposits starting December 31, 1986 up to the end of 1993. If the fund earns 9% interest
compounded annually, what is the required amount of the annual deposit?

C. LESSON WRAP-UP

Activity: Thinking about Learning

.

1. What motivated you to finish the lesson today?

________________________________________________________________________
________________________________________________________________________

2. What could you have done better to improve your learning today?
_________________________________________________________________________
_________________________________________________________________________

FAQs

1. How to determine if the problem is ordinary annuity?

________________________________________________________________________
________________________________________________________________________

Activity: Skill-building Activities

1. 𝑃 30,054.77
2. 𝑃 5,650.22
3. 24%

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Lesson Title: ANNUITIES (ANNNUITY DUE) Materials: Ballpoint, Notebook,

Learning Targets: Calculator
At the end of the lesson, you should be able to:
1. Define Annuity due References:
2. Solve annuity problems addressing annuity due Engineering Economy by Hipolito
B. Sta. Maria, 3rd Ed

Engineering Mathematics vol 2 by

Gillesania
https://corporatefinanceinstitute.co
m/resources/knowledge/finance/an
nuity-due/

A. LESSON PREVIEW/REVIEW

Introduction

The future value (FV) of an annuity is the sum of the future values of all of the payments in the annuity. It
is possible to take the FV of all cash flows and add them together, but this isn’t really practical if there are more
than a couple of payments.

If you were to manually find the FV of all the payments, it would be important to be clear about when the
start and end of the annuity is. For an annuity-due, the payments occur at the beginning of each period, so the
first payment is at the inception of the annuity, and the last one occurs one period before the termination.

Examples of annuity due payments include rentals, leases, and insurance payments, which are made to
cover services provided in the period following the payment.

B. MAIN LESSON

Content Notes

ANNUITY DUE

In annuity due, the equal payments are made at the beginning of each compounding period starting from
the first period.

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Formulas:
𝑭 𝒊
𝑨= [ ]
𝟏+𝒊 (𝟏 + 𝒊)𝒏 − 𝟏

(𝟏 + 𝒊)𝒏 − 𝟏
𝑭 = 𝑨[ ] (𝟏 + 𝒊)
𝒊

(1+𝑖)𝑛 −1
Also, from 𝐹 = 𝑃(1 + 𝑖)𝑛 and 𝐹 = 𝐴[ 𝑖
] (1 + 𝑖)

(1 + 𝑖)𝑛 − 1
𝑃(1 + 𝑖)𝑛 = 𝐴 [ ] (1 + 𝑖)
𝑖
(1 + 𝑖)𝑛 − 1 (1 + 𝑖) 𝑨 (𝟏 + 𝒊)𝒏 − 𝟏
𝑃 = 𝐴[ ] → 𝑃 = [ ]
𝑖 (1 + 𝑖)𝑛 (𝟏 + 𝒊)𝒏−𝟏 𝒊

(𝟏 + 𝒊)𝒏 − 𝟏 Observe:
𝑷 = 𝑨[ ] (𝟏 + 𝒊) PV of an Annuity Due
𝒊(𝟏 + 𝒊)𝒏 = PV of Ordinary Annuity * (1+i)
OR
𝟏 𝟏
𝑷 = 𝑨[ − ] (𝟏 + 𝒊)
𝒊 𝒊(𝟏 + 𝒊)𝒏

The diagram below shows the cash flow in annuity due.

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Example 1: A contractor bought a concrete mixer at P120,000 if paid in cash. The mixer may also be
purchased by installment to be paid within 5 years. If money is worth 8% compounded
annually, the amount of each annual payments are made at the beginning of each year.
Given:
𝑷 = 𝑷 𝟏𝟐𝟎, 𝟎𝟎𝟎, 𝒊 = 𝒓 = 𝟎. 𝟎𝟖, 𝒎 = 𝟏, 𝒕 = 𝟓 −→ 𝒏 = 𝒕𝒎 = 𝟓
Analysis: each annual payments are made at the beginning of each year means it’s ANNUITY DUE

Solution:
(𝟏 + 𝒊)𝒏 − 𝟏
𝑷 = 𝑨[ ] (𝟏 + 𝒊)
𝒊(𝟏 + 𝒊)𝒏
or
𝑷 𝒊(𝟏 + 𝒊)𝒏
𝑨= [ ]
(𝟏 + 𝒊) (𝟏 + 𝒊)𝒏 − 𝟏

120,000 0.08(1 + 0.08)5

𝑨= [ ]
(1 + 0.08) (1 + 0.08)5 − 1

0.08(1 + 0.08)4
𝑨 = 120,000 [ ]
(1 + 0.08)5 − 1

𝑨 = 𝑷 𝟐𝟕, 𝟖𝟐𝟖. 𝟒𝟗
Example 2: At the beginning of each month, $200 is deposited into a retirement fund. The fund earns
6% compounded monthly, and paid into the account at the end of the month. How much is
in the account if deposits are made for 10 years?
Given:
𝑷 = $ 𝟐𝟎𝟎, 𝒓 = 𝟎. 𝟎𝟔, 𝒎 = 𝟏𝟐, 𝒕 = 𝟏𝟎
Analysis: each annual payments are made at the beginning of each month means it’s ANNUITY DUE

Solution:
𝒓 0.06
𝒊= = = 𝟎. 𝟎𝟎𝟓 𝑎𝑛𝑑 𝒏 = 𝒕𝒎 = 10(12) = 𝟏𝟐𝟎
𝒎 12

(𝟏 + 𝒊)𝒏 − 𝟏
𝑭 = 𝑨[ ] (𝟏 + 𝒊)
𝒊
(1 + 0.005)120 − 1
𝑭 = 200 [ ] (1 + 0.005)
0.005

𝑭 = $ 𝟑𝟐, 𝟗𝟑𝟗. 𝟕𝟓

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Activity: Skill-building Activities

SOLVE FOR THE FOLLOWING PROBLEM

1. A farmer bought a tractor costing Php 25,000 payable in ten semi-

annual payments, each installment payable at the beginning of each
period. If the rate of interest is 26% compounded semi-annually,
determine the amount of each installment.

2. A man bought an equipment costing P60,000 payable in 12 quarterly payments each installment
payable at the beginning of each period. The rate of interest is 24% compounded quarterly. What
is the amount of each payment

3. Find the difference between the sums of annuity due and ordinary annuity for the following data
Periodic payment = P14,000

Term = 16 years
Interest rate = 10% compounded quarterly

Activity: Check for Understanding

1 A young woman 22 years old has just graduated from college. She accepts a good job and desire to
establish her own retirement fund. At the beginning of each year thereafter she plans to deposit P 2,000
in a fund at 15% annual interest. How old will she when the fund has an accumulated value of P
1,000,000

C. LESSON WRAP-UP

Activity: Thinking about Learning

1. What motivated you to finish the lesson today?

________________________________________________________________________
________________________________________________________________________

2. What could you have done better to improve your learning today?
_________________________________________________________________________
_________________________________________________________________________

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Name:_________________________________________________________ Class number: ______

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FAQs

1. How to identify if the problem is annuity due?

________________________________________________________________________
________________________________________________________________________

2. It is need to create a cash flow diagram in anuity due?

________________________________________________________________________
________________________________________________________________________

Activity: Skill-building Activities

1. P 4,077.20
2. P 7,371.91
3. P 53,991.62

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Name:_________________________________________________________ Class number: ______

Section: ____________ Schedule: ________________________________ Date: _______________

Lesson Title: ANNUITIES (DEFERRED ANNUITY) Materials: Ballpoint, Notebook,

Learning Targets: Calculator
At the end of the lesson, you should be able to: References:
1. Define deferred annuity Engineering Economy by Hipolito
2. identify that a situation is a deferred annuity B. Sta. Maria, 3rd Ed
3. Solve problems in deferred annuity
Engineering Mathematics vol 2 by
Gillesania

A. LESSON PREVIEW/REVIEW

Introduction
_____________

B. MAIN LESSON

Activity 2: Content Notes

DEFERRED ANUITY

An ordinary annuity where the first cash flow of the series is not at the end of the first period or
it is deferred for sometime.

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F=
[
A (1 + i)n -1 ] P=
[
A (1+ i)n -1 ]
i i(1+ i)( k +n)
Example 1: Takao buys a piece of lot for P100,000 down payment and 10 deferred semi-annual
payment pf P8,000 each starting from 3 years from now. What is the present value of the
lot if the rate of interest is 12% compounded semi-annually

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Section: ____________ Schedule: ________________________________ Date: _______________

Solution: Analyze the problem using cash flow diagram, we have a inflow of lot and a outflow of
P8,000 annuity and P100,000 down payment as shown in the cash flow

PLOT = P100,000 + PA
[
A (1+ i)n -1 A (1+ i)n -1] [ ]
PA = i(1 + i)( k +n) i(1 + i)( k +n)
éæ 0.12 ö10 ù
P8,000êç1 + ÷ -1ú
êè 2 ø ú
ë û

PA =
0.12 15 æ 0.12 ö
(1+ ) ç ÷

2 è 2 ø
PA = P43,999.08

PLOT = P100,000 + P43,999.09

PLOT = P143,999.08

Example 2: You need P4,000 per year for four years to go to college. Your father invested P5,000 in
7% account for your education when you were born. If you withdraw at the end of your
17th, 18th, 19th and 20th birthday how much will left in the account at the end of your
21st birthday?

Solution: Analyze the problem using cash flow diagram, we have a inflow P4,000 annuity and a
remaining money at year 21, outflow of P5,0000 deposit as shown in the cash flow

F21 + FA = F0; F21= F0- FA

FA = [
A (1+ i)n -1 ](1+ i) 1 = P4,000[(1+ 0.07)4 -1](1+ 0.07)
i 0.07

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Name:_________________________________________________________ Class number: ______

Section: ____________ Schedule: ________________________________ Date: _______________

FA = P19,002.96

F0 = P5,000(1+ i)21
F0 = P20,702.81
F21 = P20,702.81 - P19,002.96
F21 = P1,699.86 = P1,700

Example 3: In five years P18,000 will be bedded to pay for a building renovation. In order to generate
this sum an annuity consisting of three annual payments is established now. What
payment is necessary if money is worth 15% annually

Solution: PA =PF
[
A (1+ i)n -1 ]= F
(1+ i)n i (1+ i)n
[
A (1+ 0.15)3 -1 ]= P18,000
3
(1+ 0.15) (0.15) (1+ 0.15)5
A = P3,919.53

Activity 3: Skill-building Activities

SOLVE FOR THE FOLLOWING PROBLEM

1. What lump sum of money must be deposited in a bank account

at present time so that Php 500 monthly can be withdrawn for five years
with the first withdrawal scheduled six years from today? Interest rate
is 9% compounded quarterly.

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Name:_________________________________________________________ Class number: ______

Section: ____________ Schedule: ________________________________ Date: _______________

2. Tatsumi invested Php 10,000 now for the college education of his
three-year old son. If the fund
earns 14% effective, how much will the sun get each year starting from 19th to 22nd birthday?

3. Mr. Nara borrows P600,000 at 12% compounded annually agreeing to repay the loan in 15 equal
payments. How much of the original principal is still unpaid after he has made the 8th payment?

4. The present value of an annuity of “P” pesos payable annually for 8 years, with the first payment at
the end of 10 years, is P187,481.25. Find the value of “P” if money is worth 5%

5. Find the present value of an annuity of P30,000 payable annually for 10 years with the first
payment at the end of the 10th year, if the money is worth 8% compounded annually.

Activity : Check for Understanding

1. Today you invest P100,00 into a fund that pays 25% interest compounded annually. Three years
later you borrow P50,000 from a bank at 20% annual interest and invest in the fund. Two years
later you withdraw enough money from the fund to repay the bank loan and all interest due on it.
Three years from this withdrawal you taking P20,000 per year out of the fund. After five
withdrawals you withdrawn the balance in the fund. How much was withdrawn?

2. If P10,000 is deposited each year for 9 years, how much annuity can a person get annually
from the bank every year for 8 years starting one year after the 9th deposit is made. Cost of
money is 14%

C. LESSON WRAP-UP

Activity : Thinking about Learning

Think about your Learning

1. What motivated you to finish the lesson today?

________________________________________________________________________
________________________________________________________________________

2. What could you have done better to improve your learning today?
_________________________________________________________________________
_________________________________________________________________________

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 ECO 017: Engineering Economics
Module #8 Student Activity Sheet

Name:_________________________________________________________ Class number: ______

Section: ____________ Schedule: ________________________________ Date: _______________

FAQs

1. How to identify if the problem is annuity due?

________________________________________________________________________
________________________________________________________________________

2. It is need to create a cash flow diagram in annuity due?

________________________________________________________________________
________________________________________________________________________
KEY TO CORRECTIONS
CONGRATULATIONS!
Activity

1. P14,170.27
2. P36,294.49
3. P402,040
4. P45,000.06
5. P100,701.34

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 ECO 017: Engineering Economics
Module #9 Student Activity Sheet

Name:_________________________________________________________ Class number: ______

Section: ____________ Schedule: ________________________________ Date: _______________

Lesson Title: PERPETUITY Materials: Ballpoint, Notebook,

Learning Targets: Calculator
At the end of the lesson, you should be able to: Text book: Engineering Economy
1. Define perpetuity by Hipolito B. Sta. Maria, 3rd Ed
2. Give example of perpetuity References:
3. Solve problems in perpetuity 1.Engineering Mathematics vol 2
by Gillesania

A. LESSON PREVIEW/REVIEW

Introduction

_______________
B. MAIN LESSON

Activity 2: Content Notes

PERPETUITY

It is an annuity where series of uniform payment where they extend forever or continues in
indefinite time.

From the formula of present worth of an ordinary annuity

= é1- (1+ i)-n ù
P A
ê i ú

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Section: ____________ Schedule: ________________________________ Date: _______________

ë û

The expression (1 + i)-n approaches to zero when n approaches to infinity. Thus, the present worth
of a perpetuity becomes:
A
P= i
Example 1: Find the present worth of perpetuity of P6,000 annually with an interest rate of 10%
annually

Solution: P = A = P6,000
i 0.1

P = P60,000

Example 2: Find the present worth of perpetuity of P6,000 annually with an interest rate of 10%
annually, if the first payment will be given after 3 years.

Solution:
PA = P6,000 = P60,000
0.10
P
A P60,000
P0 = (1+ i) =
n
(1+ i)2 4
Po = P49,586.77

Example 3: Find the present worth of perpetuity of P6,000 annually with an interest rate of 10%
compounded monthly

Solution:
The compounding period is not equal to payment period so find the equivalent rate of
compounded annually to compounded monthly.

ERImonthly = ERI
(1+ i)12 = (1+ 0.10)

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1 + i = 1.00797 i
= 0.00797

P= P6,000
0.00797
P =P752,432.20

AMORTIZATION

Amortization is any method of repaying ta debt, the principal and interest included, usually by a
series of equal payments at the equal interval of time

Example: A debt of P20,000 with interest at rate of 14% compounded semi-annually is to be

amortized by 4 equal payments at the end of each 6 months; the first payment is to be
made after 2 years. Find the semi-annual payment and construct an amortization

Solution:
é (1+ i)n -1ù
P=A ê n ú
ë (1+ i) (i) û
é æ 0.14 ö 4 ù
ê ç1 + ÷ -1 ú
P20,000 = A ê è 2ø ú
ú
êæ 0.14 ö7 æ 0.14 ö
êç1 + ÷ç ÷ú
ëè 2 ø è 2 øû
P20,000 = A (2.7650)
A = P20,000
3.3872
A = 7,233.34

Payment Principal repaid

Outstanding Interest at the end of
made at the at the end of
Period Principal of Period of period
end of period period
period (I = P(r/m))
(A) (P=A-I)
1 P20,000 P1,400 = P20,000(0.14/2)
2 P21,400 P1,498
3 P22,898 P1,602.86
4 P24,500.86 P1,715.06 P7,233.34 P5,518.28
5 P18,982.58 P1,835 P7,233.34 P5,905.56
6 P13,077.02 P1,084.65 P7,233.34 P6,319.95
7 P6,757.07 P7,47.24 P7,233.34 P6,763.34

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 ECO 017: Engineering Economics
Module #9 Student Activity Sheet

Name:_________________________________________________________ Class number: ______

Section: ____________ Schedule: ________________________________ Date: _______________

Activity 3: Skill-building Activities

ITS TIME TO APPLY WHAT YOU LEARN. TRY TO

SOLVE THE GIVEN PROBLEM.

1. Find the present value of a perpetuity of P15,000 payable semi-

annually if money is worth 8% compounded quarterly.

2. Find the present worth of perpetuity of P10,000 payable quarterly if

money is worth 10% compounded monthly.

3. Find the present worth of perpetuity of P10,000 semi annually with an interest rate of
10% quarterly, if the first payment will be given after 5 years.

Activity 5: Check for Understanding

1. What amount of money invested today at 15% interest can provide the following
scholarships: P30,000 at the end of each year for 6 years; P40,000 for the next 6 years and
P50,000 thereafter.

C. LESSON WRAP-UP

Activity : Thinking about Learning

.
1. What motivated you to finish the lesson today?
________________________________________________________________________
________________________________________________________________________

2. What could you have done better to improve your learning today?
_________________________________________________________________________
_________________________________________________________________________

KEY TO CORRECTIONS (refer TG’s)

Activity 3 ATTACH ADDITIONAL

SHEETS OF PAPER FOR
1. P371,287.13 YOUR SOLUTIONS!
2. P396,683.772
3. P133,601.72

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 ECO 017: Engineering Economics
Module #10 Student Activity Sheet

Name:_________________________________________________________ Class number: ______

Section: ____________ Schedule: ________________________________ Date: _______________

Lesson Title: CAPITALIZED AND ANNUAL COST Materials: Ballpoint, Notebook,

Learning Targets: Calculator
At the end of the lesson, you should be able to:
1. Define capitalized cost References:
2. Define annual cost Engineering Economy by Hipolito
3. Solve problems involving capitalized cost and annual cost B. Sta. Maria, 3rd Ed

Engineering Mathematics vol 2 by

Gillesania

investopedia.com

A. LESSON PREVIEW/REVIEW

Introduction

B. MAIN LESSON

Content Notes
CAPITALIZED COST

Capitalized cost(K) is an application of perpetuity. The capitalized cost of a project or

structure is the sum of the first cost (FC) and the present worth of all future payments and
replacements which is assumed to continue forever

If a project requires a first cost of FC, annual operation and maintenance of OM for n
years, a salvage value of SV after every n years; and a replacement cost of RC after every end of n
years, then the capitalized cost is;

Capitalized cos, K
= +OM + RC-SV
K FC

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Section: ____________ Schedule: ________________________________ Date: _______________

i(1+ i)n -1
If RC is not specified, use RC = FC

Capitalized cost may also be defined as the first cost plus the present worth of annual
maintenance and operation cost plus the present worth of depreciation assumed to continue
forever

Example 1: Determine the capitalized cost of an equipment costing P2 million with an annual
maintenance of P200,000 if money is worth 20% annually.

Solution: The only given in the problem is first cost and maintenance cost therefore
OM
K=FC+
i
P200,000
K = P2,000,000 +
0.20
K = P3,000,000

Example 2: A financial analysis of two bridges based on capitalized cost on the following data

Bridge A B
Initial cost P2,000,000 P2,500,000
Cost of renewal P2,000,000 P2,500,000
Salvage value 0 P200,000
Annual maintenance P100,000 0
Repair every 5 years P500,000 P600,000
Life 30 years 40 years
It the
rate of interest is 18% compounded annually. Determine the capitalized cost for each

Solution:

= +OM + RC-SV
K FC
A i (1+ i)n -1

K A = P2,000,000 + P100,000 + P500,000 + P2,000,000 -0

0.18(1+ i)5 -1 (1+ 0.18)30 -1

KA = P2,957875.18

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Name:_________________________________________________________ Class number: ______

Section: ____________ Schedule: ________________________________ Date: _______________

= +OM + RC-SV
K FC
B i (1+ i)n -1

K B = P2,500,000 + P600,000 + P2,000,000 - P200,000

(1+ i)5 -1(1+ 0.18)40 -1

KB = P2,968,995.35

Example 3: At 6% interest rate, find the capitalized cost of a bridge whose cost is P200 million and
life is 20 years, if the bridge must be partially rebuilt at a cost of P100 million at the end
of each 20 years

Solution:
RC
K=FC+
(1+ i)n -1

= + P100M
K P200M
(1+ 0.6)20 -1
K = P245.31 M

Example 4: Determine the capitalized cost of a research laboratory which requires P5 million for
original construction; P100,000 at the end of every year for first 3 years and then
P120,000 thereafter, for operating expenses and P500,000 every year fir replacement of
equipment.

Solution:

Base on our cash-flow diagram we have

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Section: ____________ Schedule: ________________________________ Date: _______________

RC
F=FC+PA+PP+ (1+ i)n -1

PA =
[
A (1 + i)n - 1 ]= [
P100,000 (1+ 0.12)3 -1 ]
(1 + i)n (i) (1+ 0.12)3 (0.12)

PA = P240,183.13 Note: “n” in numerator is the number of payment and n in the

denominator is the number of period

P
Pp = Perpetuity

(1+ i)3

= P120,000
PP
0.12(1+ 0.12) 3

Pp = P711,780.25

P500,000
K = P5 million + P240,813.13 + P711,780.25 +
(1+0.12)5 -1

K = P6,607,837.26

ANNUAL COST

The Annual cost of project is the annual interest investment + Annual operation and
maintenance + annual depreciation cost

In accountancy, depreciation refers to two aspects of the same concept: first, the actual
decrease in value of fair value of an asset, such as the decrease in value of factory equipment each
year as it is used and wears, and second, the allocation in accounting statements of the original cost
of the assets to periods in which the assets are used (depreciation with the matching principle).

In relation to capitalized cost (K), where annual cost is the total annually cost of the project
while the capitalized is the total present cost of the project, so we have;

AC
K= i; AC = Ki

Therefore;
("#$%&)(

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Name:_________________________________________________________ Class number: ______

Section: ____________ Schedule: ________________________________ Date: _______________
AC = (FC)i + OM +
()*()!$)

Example 1: A machine has an initial cost of P80,000 with a useful life of 20 years with a salvage
value of 20% of the initial cost of the machine. What is the annual cost of the machine if it
has a annually maintenance cost of P6,0000 and an interest rate of 10%?

Solution: ("#$%&)(
AC = (FC)i + OM +
()*()!$)

AC = P80,000(0.10) + P6,000 + [P80,000 -0.20(P80,000)](0.10)

(1+ 0.10)20 -1
AC = P15,117.42

Example 2: A bridge that was constructed at a cost of P2,000,000 is expected to last 30 years with an
annual maintenance cost of P100,000. In addition, the bridge needed to be repaired every
5 years at a cost of P500,000. What is the Annual cost of the bridge if the interest rate is
18% per annum?

Solution:
AC = (FC)i + OM + ("#$%&)(

()*()!$)

AC = P2 million + P100,000 +
(P500,000)(0.18) +
(P2milllion)(0.18)
(1+ 0.18)5 -1 (1+ 0.18)30 -1
AC = P532,41

Activity: Skill-building Activities

ITS TIME TO APPLY WHAT YOU LEARN. TRY TO

SOLVE THE GIVEN PROBLEMS.

1. Determine the capitalized cost of a structure that requires an initial

investment of Php 1,500,000 and an annual maintenance of P
150,000.Interest is 15%.

2. A manufacturing plant installed a new boiler at a total cost of

P150,000 and is estimated to have a useful life of 10 years. It is estimated to have a scrap value
at the end of the useful life P5,000. If interest is 12% compounded annually, determine its
capitalized cost.

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 ECO 017: Engineering Economics
Module #10 Student Activity Sheet

Name:_________________________________________________________ Class number: ______

Section: ____________ Schedule: ________________________________ Date: _______________

3. A new engine was installed by a textile plant at a cost of P300,000 and projected to have a
useful life of 15 years. At the end of its useful life, it is estimated to have a salvage value of
P30,000. Determine its capitalized cost if interest rate is 18% compounded annually.
4. A concrete pavement on a street would cost P10,000 and would last for 5 years with negligible
repairs. At the end of each years. P1,000 would be spent to remove the old surface before
P10,000 is spent again to lay a new surface. Find the annual cost of the pavement at 5%

5. An asset was purchased for P100,000 and retired at the end of 15 years. with a salvage value of
P4,000. The annual operating cost was P18,000. Determine the annual cost of the asset based
on an interest rate of 8%

6. Determine the capitalized cost of a research laboratory which requires P5,000,000 for original
construction, P100,000 at the end of every year for the first 6 years and then P120,000 each
year thereafter for operating expenses and P500, 000 every 5 years for replacement of with
interest at 12% per annum.

Activity: Check for Understanding

1. Calculate the capitalized cost of a project that has an initial cost of P3, 000,000 and an additional
cost of P100, 000 at the end of every 10 yrs. The annual operating costs will be P100, 000 at the
end of every year for the first 4 years and P160, 000 thereafter. In addition, there is expected to be
recurring major rework cost of P300, 000 every 13 yrs. Assume i =15%

2. Calculate the annual cost of the project that has an initial cost of P2.5 Million and an additional
investment cost of 1 Million at the end of every ten years. The annual operating cost will be
P100,000 at the end of every year for the first four years and P150,000 thereafter. In addition,
there is expected to be recurring major rework cost of P200,000 every 13 years. Assume i =
10%

C. LESSON WRAP-UP

Activity: Thinking about Learning

1. What motivated you to finish the lesson today?

_______________________________________________________________________
_______________________________________________________________________

2. What could you have done better to improve your learning today?
_________________________________________________________________________
_________________________________________________________________________

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 ECO 017: Engineering Economics
Module #11 Student Activity Sheet

Name:_________________________________________________________ Class number: ______

Section: ____________ Schedule: ________________________________ Date: _______________

Lesson Title: GRADIENT Materials: Ballpoint, Notebook,

Learning Targets: Calculator
At the end of the lesson, you should be able to: References:
1. Define the concept of gradient Engineering Economy by Hipolito
2. Define different types of gradient B. Sta. Maria, 3rd Ed
3. Solve problems involving gradients
Engineering Mathematics vol 2 by
Gillesania

A. LESSON PREVIEW/REVIEW

Introduction

B. MAIN LESSON

Activity 2: Content Notes

UNIFORM GRADIENT UNIFORM SERIES
The change in the amount of an account that has uniform increases or decreases applied to it
for some number of compounding periods.

ARITMETHIC GRADIENT

An arithmetic gradient cash flow is one wherein the cash flow changes (increases or decreases)
by the same amount in each cash flow period. In certain, economic analysis problems involves receipt
or disbursement that increase or decrease by a uniform amount each period. For example,
maintenance and repair expenses on specific equipment or property may increase by a relatively
constant amount each period.
Suppose that the maintenance expense on a certain machine is ＄100 at the end of the
first year and increasing at a constant rate of ＄25 each year for 3 years.

This cash flow may be resolved into two components

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Name:_________________________________________________________ Class number: ______

Section: ____________ Schedule: ________________________________ Date: _______________

= +

n=4 A = ＄100 n = 4 G = ＄500 n = 4

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Name:_________________________________________________________ Class number: ______

Section: ____________ Schedule: ________________________________ Date: _______________

G is known as the uniform gradient

P=PA+PG

é(1+ i)n -1ù

PA = A
êë (1+ i) (i) úû n

PG = G(1 + i)-2 + 2G(1 + i)-3 + . . . (n-1)G(1 + i)-n

P = G é(1+ i)n -1 - nùé 1 ù

G ê
i ëiúûêë(1+ i) n ú
û

Therefore:

é (1+ i)n -1ù G é (1+ i)n -1 ùé 1 ù

n
P=A ê n ú + ê - úê n ú

ë (1+ i) (i) û ië i ûë (1+ i) û

F = Aéê(1+ i)n -1ùú + G éê(1+ i)n -1 - nùú
i i i
ë û ë û

Suppose that the maintenance expense on a certain machine is P10,000 at the end of the first year
and decreasing at a constant rate of P2,500 each year for 3 years

= -

é (1+ i)n -1ù G é(1+ i)n -1 ùé

n
1 ù
P=A ê n ú - ê - úê n ú

ë (1+ i) (i) û i ë i ûë (1+ i) û

é (1+ i)n -1ù ù
- G é(1+ i) -1 - n
n
F=A
ê ú ê ú

ë i û i ë i û

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 ECO 017: Engineering Economics
Module #11 Student Activity Sheet

Name:_________________________________________________________ Class number: ______

Section: ____________ Schedule: ________________________________ Date: _______________

Example: The DPWH expects the cost of maintenance for a particular piece of heavy equipment to
be P50,000 in year 1, P55,000 in year 2, and amounts increasing by P5,000 through year
10. At an interest rate of 10% per year, the present worth of the maintenance cost is
nearest to:
Solution:

é (1+ i)n -1ù G é (1+ i)n -1 ùé 1 ù

n
P=A ê n ú + ê - úê n ú

ë (1+ i) (i) û ië i ûë (1+ i) û

é 10 (1+ 0.10 ) -1
ù P5,000 é 10
(1+ 0.10 ) -1
ù é æ
1 öù
P = P50,000 + ç ÷
ú
ê (1+ 0.10)10 (0.10) 0.10 ê 0.10 -10ú êêèç (1+ 0.10)10 ø÷ ú
ú

ë û ë û ë û
P = P50,000(6.14457) + P5,000(22.89134)

P = P421,685.07
Example: A loan to be amortized by a group of four end of year payments forming an ascending
arithmetic progression. The initial payment was to be P5,000 and the difference between
successive payments was to be P400. But the loan was renegotiated to provide for the
payment of equal rather than uniformly varying sums. If the interest rate of the loan was
15%, what was the annual payment?

Solution:

= +

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 ECO 017: Engineering Economics
Module #11 Student Activity Sheet

Name:_________________________________________________________ Class number: ______

Section: ____________ Schedule: ________________________________ Date: _______________

é(1+ i)n -1ù G é (1+ i)n -1 ùé 1 ù

+ n
P=A ê n ú ê - úê n ú

ë (1+ i) (i) û i ë i ûë (1+ i) û

P = P5,000
é 4 (1+0.15 ) -1
ù
+
P400 é 4
(1+ 0.15) -1
ù éç æ
1 ö÷ ù
ú
ê (1+0.15)4 (0.15) 0.15 ê 0.15 - 4ú êêèç (1+ 0.15)4 ø÷úú
ë û ë û ë û
P = P5,000(2.8550) + P400(3.7865)
P = P15,789.60

é(1+ i)4 -1ù

ê ú
A’ = P15,789.60

ë (1+ i)4 (i)û

A’ (2.8850) =P15,789.60

A’ = P5,530.51

Activity: Skill-building Activities

ITS TIME TO APPLY WHAT YOU LEARN. TRY TO

SOLVE THE GIVEN PROBLEMS.

1. The cash flow associated with a strip mining operation is expected to

be P2,000,000 in year 1, P1,800,000 in year 2, and amounts
decreasing by P200,000 per year through 8. At an interest rate of 12%
per year, the equivalent annual cash flow is nearest to:

2. The present worth of of P40,000 in the first year and amounts of

increasing by P3,000 per year through five years at an interest rate of
13% per year is?

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 ECO 017: Engineering Economics
Module #11 Student Activity Sheet

Name:_________________________________________________________ Class number: ______

Section: ____________ Schedule: ________________________________ Date: _______________

Activity: Check for Understanding

1. The present worth of of P40,000 in the first year and amounts of decreasing by P3,000
per year through five years at an interest rate of 13% per year is?

C. LESSON WRAP-UP

Activity: Thinking about Learning

1. What motivated you to finish the lesson today?

_______________________________________________________________________
_______________________________________________________________________

2. What could you have done better to improve your learning today?
_________________________________________________________________________
_________________________________________________________________________

KEY TO CORRECTIONS (refer TG’s)

Activity 3
ATTACH ADDITIONAL SHEETS OF
1. P1,417,371.218
2. P159,229.98 PAPER FOR YOUR SOLUTIONS!

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 ECO 017: Engineering Economics
Module #12 Student Activity Sheet

Name:_________________________________________________________ Class number: ______

Section: ____________ Schedule: ________________________________ Date: _______________

Lesson Title: DEPRECIATION Materials:

Learning Targets: Ballpoint and or highlighter
At the end of the module, you should be able to:
1. Define the concept of depreciation References:
2. Identify the causes of depreciation Engineering Economy by Hipolito
3. Determine the use of depreciation B. Sta. Maria, 3rd Ed

Engineering Mathematics vol 2 by

Gillesania

investopedia.com

A. LESSON PREVIEW/REVIEW

Introduction

B. MAIN LESSON

Content Notes

DEPRECIATION

Depreciation means the decrease in the value of physical properties or assets with the passage of
time and use. It is the non-cash method of representing the reduction in value of a tangible asset.
Specifically, it is an accounting concept that sets an annual deduction considering the factor of time and
use on an asset's value. An asset is depreciable if it has a determinable useful life of more than one year
in business or something to produce an income.

In an accounting context a systematic allocation of the cost of an asset over its depreciable life.
Depreciable life is related to deterioration and obsolescence

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CAUSES OF DEPRECIATION

Physical Depreciation

Depreciation resulting in physical impairment of an asset is known as physical depreciation. This

type of depreciation results in the lowering of the ability of a physical asset to render its intended service.
The primary causes of physical depreciation are (a) deterioration due to action of the elements including
the corrosion of pipe, the rotting of timbers, chemical decomposition and so on. (b) Wear and tear charges
(c) Physical decay, (d) Time factors etc.

Depreciation is the decrease in value of physical properties with the passage of time and use. Most
assets are worthless as they age. Production equipment gradually becomes less valuable through wear
and tear. This lessening in value is recognized in accounting practices as an operating expense. Instead
of charging the full purchase price of a new asset as one-time expense, the outlay is spread over the life
of the asset in the accounting records. Annual depreciation deductions arc intended to match the yearly
fraction of value used by an asset in the production of income over the assets actual economic life. The
actual amount of depreciation can never be established until the asset is retired from service. Depreciation
can be defined in three senses like physical depreciation, which is caused due to physical decay. Economic
depreciation is the loss of value of an asset due to outdated technology and in accounting sense
depreciation is the estimated value of fall in the worth of an asset. In accounting, depreciation charge is
included in the cost of production of the asset. Depreciation is a permanent continuing and gradual
shrinkage in the book value of a fixed

Functional Depreciation

Functional depreciation results not from a deterioration in the assets ability to serve its intended
purpose, but from a change in the demand for the services it can render. The demand for the services of
an asset may change it is more profitable to use a more efficient, unit, there is no longer work for the asset
to do, or the work to the done exceeds the capacity of the asset.

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Technological depreciation
Due to advancement of new technology, the old technology becomes outdated, so it loses its value.
Obsolescence resulting from the discovery of another asset that is sufficiently superior to make it
uneconomical to continue using the original asset. Assets also become obsolete when they are no longer
needed.

Depreciation due to Accident

Sometimes due to accident or sudden failure the asset loses its technological characteristic
inherent in it.

Depreciation due to Depletion

Consumption of an exhaustible natural resources to produce product or services is termed as

depletion. Removal of oil, timber, rock, or minerals from a site decreases the value of the holding. This
decrease is compensated by a proportionate reduction in earnings derived from the resources.

Monetary Depreciation

A change in the price level also decreases the value of owned assets. If prices rise during the life
of an asset, then comparable replacement become more expensive. This means that the capital recovered
will be insufficient to provide an adequate substitute for the worn out asset.

Depreciation due to Time Factor

There are some assets, which loses its values after a particular period. Particularly the assets
having lease, copyrights and patents right loses its value after the time is over.

Depreciation due to Deferred Maintenance

Sometimes the loss of value of asset begins very quickly due to deferred maintenance. If proper
materials are not used or instructions to operate the machine are not properly obeyed the loss of value
start.

Depreciation Accounting

Before going through the different method involved in the calculation of depreciation we should
have sufficient knowledge about the depreciable property. Depreciable property is that property which can
amortize or depreciated. Depreciable property may be tangible and intangible. Tangible property is any
property that can be seen or touched. Intangible property are property which are not tangible like copyrights
and patent rights. Depreciable tangible property is of two types i.e. Real and personal. Personal property
are those property, which is not real estate, they are machinery and equipment.

Real property is land and anything that is erected on. Land is never depreciable. Property is
depreciable if it fulfills the following requirements:
a) The property must be used in business or help to produce income.

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b) The property must be something that wears out, decays, deteriorates, becomes obsolete, or
loses value from natural causes.
c) It must have determinable life and that life must be longer than 1 year.

In general, if property does not fulfill the above conditions can’t be regarded as depreciable
property.

Depreciation for Tax Purposes

▪ Depreciable life - the period over which an asset is depreciated (recovery period).

▪ Depreciation is a non-cash cost - money does not change hands during the recovery period. (Note:
The asset is already paid for or money has been borrowed and principal & interest payments are
being made.)

▪ Depreciation is used to allocate an asset’s loss of value over time.

▪ Depreciation is deducted from revenue and reduces the taxable income of a business over time
which produces a cash flow on an after tax-basis.

Depreciation Method

There are various depreciation method have evolved from time to time but there are three basic
methods to understand the various calculation of depreciation schedules that are presently, in effect, it is
first necessary to become acquainted with the three methods on which the current schedules are based.
Some current depreciation schedules are based on straight line depreciation and other are based on a
combination of straight line depreciation and declining balance depreciation.

Before going to discuss the basic methods and other methods of depreciation, we should know
some additional terms for clear understanding of the problem.

FC= First Cost or Purchase price (unadjusted basis) of assets. (This is the initial cost of occurring an asset
(purchase price + sales taxes) including transportation expenses.

Sv= Salvage value or future value at end of asset’s life. It is the expected selling price of a property when
the asset can no longer be used by its owner.

n = useful (tax) life of asset - The expected period of time that a property will be used in a trade or business
or to produce income.

m = number of years of depreciation

d = Annual depreciation charges.

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BVm = Book value shown on accounting records at end of “m” years. It is the original cost, basis of the
property, including any adjustment.

Dm = Total depreciation for m years.

The methods use in depreciation are

▪ Straight-line Method (SLD)
▪ Sinking Fund Method
▪ Sum of the Years Digit Method (SOYD)
▪ Declining Balance Method (DBM)
▪ Double declining Balance
▪ Modified Accelerated Cost Recovery System
▪ Working Hours Method

Activity: Skill-building Activities

IDENTIFY THE STATEMENT IF TRUE OR FALSE

1. Depreciation refers to the increase in the value of an asset, due to usage of time. An
asset may depreciate physically or functionally

2. Depreciation occur because of consumption of an exhaustible natural resources to

produce product or services is termed as depletion. Removal of oil, timber, rock, or
minerals from a site decreases the value of the holding. This decrease is compensated
by a proportionate reduction in earnings derived from the resources.

3. the primary causes of physical depreciation are (a) deterioration due to action of the
elements including the corrosion of pipe, the rotting of timbers, chemical decomposition
and so on. (b) Wear and tear charges (c) Physical decay, (d) Time factors etc.

4. Any technology devices can be sell at increasing value as time increase

5. A change in the price level also decreases the value of owned assets. If prices rise
during the life of an asset, then comparable replacement become more expensive. This
means that the capital recovered will be insufficient to provide an adequate substitute
for the worn out asset.

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Activity: Check for Understanding

Determine the cause of depreciation

1. here are some assets, which loses its values after a particular period. Particularly the assets
having lease, copyrights and patents right loses its value after the time is over.

2. A change in the price level also decreases the value of owned assets. If prices rise during
the life of an asset, then comparable replacement become more expensive. This means that
the capital recovered will be insufficient to provide an adequate substitute for the worn out
asset.

3. Results not from a deterioration in the assets ability to serve its intended purpose, but from
a change in the demand for the services it can render. The demand for the services of an
asset may change it is more profitable to use a more efficient, unit, there is no longer work
for the asset to do, or the work to the done exceeds the capacity of the asset.

C. LESSON WRAP-UP
.

Think about your Learning

1. What motivated you to finish the lesson today?

_______________________________________________________________________
2. What could you have done better to improve your learning today?
_______________________________________________________________________

Activity

1. F
2. T
3. T
4. F
5. T

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Lesson Title: SUM OF THE YEARS’ DIGIT METHOD OF Materials: Ballpoint, Notebook,
DEPRECIATION Calculator
Learning Targets:
At the end of the module, you should be able to: References:
1. Define the methods of depreciation Sum of the years’ digit Engineering Economy by Hipolito
method, declining balance method, double declining balance B. Sta. Maria, 3rd Ed
method by their respective formulas
2. Use the stated method to solve problems involving depreciation Engineering Mathematics vol 2 by
Gillesania

Investopedia.com

A. LESSON PREVIEW/REVIEW

Introduction

B. MAIN LESSON

Content Notes

STRAIGHT-LINE METHOD (SLD)

The most widely used and simplest method for the calculation of depreciation is straight line method.
It reports equal depreciation expense each year throughout the entire useful life until the entire
asset is depreciated to its salvage value. It assumes that the value of an asset decreases at a constant
rate.

Straight line basis is a method of calculating depreciation and amortization. Also known as straight
line depreciation, it is the simplest way to work out the loss of value of an asset over time. Straight line
basis is calculated by dividing the difference between an asset's cost and its expected salvage value by
the number of years it is expected to be used.

In accounting, there are many different conventions that are designed to match sales and
expenses to the period in which they are incurred. One convention that companies embrace is referred to
as depreciation and amortization.

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Companies use depreciation for physical assets, and amortization for intangible assets such as
patents and software. Both conventions are used to expense an asset over a longer period of time, not
just in the period it was purchased. In other words, companies can stretch the cost of assets over many
different time frames, which lets them benefit from the asset without deducting the full cost

Advantages and Disadvantages of Straight Line Basis

Accountants like the straight line method because it is easy to use, renders fewer errors over the
life of the asset, and expenses the same amount every accounting period. Unlike more complex
methodologies, such as double declining balance, straight line is simple and uses just three different
variables to calculate the amount of depreciation each accounting period.

However, the simplicity of straight line basis is also one of its biggest drawbacks. One of the most
obvious pitfalls of using this method is that the useful life calculation is based on guesswork. For example,
there is always a risk that technological advancements could potentially render the asset obsolete earlier
than expected. Moreover, the straight line basis does not factor in the accelerated loss of an asset’s value
in the short-term, nor the likelihood that it will cost more to maintain as it gets older.

FORMULA:

d= !"#$% Dm = d x m BVm = FC - Dm

&
Tabulation:
End of the Depreciation Book Value at the
year Charge end of the Year
0 FC
1 d FC - d
2 d FC -2d
3 d FC -3d

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Example: What is the book value of an asset after 8 years of use if it depreciates from its
original value of P12,000 to its salvage value of 3% in 12 years

Solution:
n = 12, FC =P12,000, SV = P12,000(0.03) = P360 m = 8

BV8= ?

d = FC - SV
n

d = P12,000 - P360 = P970

12
Dm = d x m

Dm = P970 x 8 = P7,760

BV8 = P12,000 - P7,760

BV8 = P4,240

Using Table:

End of the Depreciation Book Value at

year Charge the end of the
Year
0 P12,000
1 P970 P11,030
2 P970 P10,060
3 P970 P9,090
4 P970 P8,120
5 P970 P7,150
6 P970 P6,180
7 P970 P5,210
8 P970 P4,240

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Example: A man bought equipment which cost P524,000. Freight and installation expenses cost
him P31,000 if the life of the equipment is 15 years with an estimated salvage value of
P120,000. Find its book value after 3 years

Solution:
FC = P524,000 + P31,000 = P555,000 (freight and installation is initial cost)
n = 15, SV =P120,000, m=3
BV3=?

d = FC - SV = P555,000 - P120,000 = P29,000

n 15
Dm = d x m = P29,000 x 3 = P87,000

BV3 = P555,000 - P87,000

BV3 = P468,000

SINKING FUND METHOD

The sinking fund method is a technique for depreciating an asset while generating enough money
to replace it at the end of its useful life. As depreciation charges are incurred to reflect the asset's falling
value, a matching amount of cash is invested. These funds sit in a sinking fund account and generate
interest.

Companies use depreciation to expense an asset over time, not just in the period that it was
purchased. In other words, depreciation involves stretching out the cost of assets over many different
accounting periods, enabling companies to benefit from them without deducting the full cost from net
income (NI).

One of the biggest challenges of depreciation is determining how much to expense. For
companies that want to put money aside to purchase a replacement asset upon the full depreciation of
the old one, the sinking fund method may be a viable option.

Under this method, the amount of money added to the asset-replacement fund each year is
calculated by determining the cost to replace the asset, how many years the asset is expected to last, and
the expected rate of return on the investment, as well as potential earnings from the effects
of compounding interest.

In most cases, sinking funds invest in government-backed securities, such as Treasury notes, bills,
and bonds. Investments matching the duration of the asset's life are usually used, but shorter-term
investments can be reinvested. The asset's depreciation schedule determines the investment amounts.

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Formula:

d=
(FC - SV )i Dm =
d [(1+ i)m -1] BVm = FC - Dm
(1+ i)n -1 i

Example: A piece of equipment costing P250,000 has an estimated life of 15 years with a book value
of P30,000 at the end of the period. Compute the depreciation charged and its book value
after 10 years using sinking fund method assuming i = 8%

Solution:
FC = P250,000, n = 15, SV =P3000, m = 10
BV10 = ?

d= (FC - SV )i = (P250,00 - P30,000)(0.08)

(1+ i)n -1 (1+ 0.08)15 -1
d = P8,102.50

Dm = d [(1+ i)m -1]= P8,102.5[(1+ 0.08)10 -1] = P117,377.37

i 0.08
BV10 = P250,000 - P117,377.37

BV10 = P132,622.63

Activity: Skill-building Activities

SOLVE THE FOLLOWING PROBLEM

1. An engineer bought equipment for P500,000. Other expenses

including installation amounted to P30,000. At the end of its
estimated useful life of 10 years, the salvage value will be 10% of
the first cost, using straight line method of depreciation, what is
the book value after 5 years?

2. A plant erected to manufacture socks has a first cost of 10,000,000 with an estimated salvage
value of P100,000 at the end of 25 years. Find its appraised value to the nearest P100 by the
sinking fund method, assuming at an interest rate of 6%a at the end of :a. 10 years, b. 20 years

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3. A dump truck bought for P900,000 six years ago. It will have a salvage value of P100,000 two
years from now. What is the book value at the end of 6th year. Use Straight-line Method
4. A company owns earth moving equipment that cost P100,000. After 8 years it will have estimated
salvage value of P20,000. Compute the annual depreciation cost and the book value at the end of
5 years (a) using SLD (b) Using sinking fund

5. An equipment costs P10,000 with a salvage value of P500 at the end of 10 years. Calculate the
annual depreciation cost by sinking-fund method at 4% interest.

6. A Machine was purchased on 1st January 2004 at a cost, of P58,000 and the cost of installation
Rs 8 000 his expected that its total working life will be 100,000 hours. The scrap value may be
P3,000. During the year 2004, the machine worked for 1200 hours and in 2005 for 1,350 hours.
Calculate the book value after 2005.

Activity: Check for Understanding

Solve the following problems.

1. A commercial building has a salvage value of Php 1 million after 50 years. Annual
depreciation is Php 2 M. Using the Straight Line Method, how many years after should you
sell the building for Php 30 M?

2. A machine costs Php 300,000 with a salvage value of Php 50,000 at the end of its life of 10
years. If money is worth 6% annually, use Sinking Fund Method and determine the
depreciation at the 6th year.

3. A machine costs Php 400,000 with a salvage value of Php 200,000. Life of it is six years. In
the first year, 4000 hours. In the second year, 6000 hours and 8000 hours on the third year.
The expected flow of the machine is 38000 hours in six years. What is the depreciation at
the end of the second year?

C. LESSON WRAP-UP

Thinking about Learning

1. What motivated you to finish the lesson today?

________________________________________________________________________
________________________________________________________________________

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2. What could you have done better to improve your learning today?
_________________________________________________________________________
_________________________________________________________________________

KEY TO CORRECTIONS

Activity 3

1. P291,500
2. a = P7,621,600,
b = P3,362,200
3. P300,000
4. aBV = P50,000
b.BV = P58,697.64
5. P791.26
6. P556,597.5

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Lesson Title: SUM OF THE YEARS’ DIGIT METHOD OF Materials:

DEPRECIATION Ballpoint and/or highlighter,
Learning Targets: calculator
At the end of the module, you should be able to:
1. Define the methods of depreciation Sum of the years’ digit References:
method, declining balance method, double declining balance Engineering Economy by Hipolito
method by their respective formulas B. Sta. Maria, 3rd Ed
2. Use the stated method to solve problems involving depreciation
Engineering Mathematics vol 2 by
Gillesania

Investopedia.com

A. LESSON PREVIEW/REVIEW

Introduction

B. MAIN LESSON

Content Notes

SUM OF THE YEARS’ DIGIT METHOD (SOYD)

Sum-of-the-years'-digits (SYD) is an accelerated method for calculating an asset's depreciation.

This method takes the asset's expected life and adds together the digits for each year; so if the asset was
expected to last for five years, the sum of the years' digits would be obtained by adding: 5 + 4 + 3 + 2 + 1
to get a total of 15. Each digit is then divided by this sum to determine the percentage by which the asset
should be depreciated each year, starting with the highest number in year 1.

Depreciation is a method of asset cost allocation that apportions an asset's cost to expenses for
each period expected to benefit from using the asset. Depending on the chosen cost apportionment or
depreciation rate, depreciation charges can be variable, straight-lined, or accelerated over the useful life of
an asset.

Accelerated depreciation uses decreasing charge methods, including the sum-of-the-years' digits
(SYD), providing higher depreciation costs in earlier years and lower depreciation charges in later periods.
Under the SYD method, the depreciation rate percentage for each year is calculated as the number of years

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in remaining asset life for the same year divided by the sum of remaining asset life every year through the
asset's life. As the depreciation rate decreases over time, so does the depreciation charge.

It makes sense to use an accelerated depreciation method such as the SYD method when an asset
will lose most of its value toward the beginning of its useful life — as is the case with automobiles, for
example. In the five-year example above, the SYD method would yield the following depreciationschedule:

Year 1: 5/15 = 33%

Year 2: 4/15 = 27%
Year 3: 3/15 = 20%
Year 4: 2/15 = 13%
Year 5: 1/15 = 7%

The percentages for all these years should add up to 100%.

The accelerated or decreasing cost allocation for asset depreciation, such as the sum-of-the-years'-
digits method, better matches the cost of using an asset to the benefit the asset use provides each year
over the economic life of the asset. The benefit of using an asset will decline as the asset gets older,
meaning an asset provides greater service value in earlier years. Therefore, charging higher depreciation
costs early on and decreasing depreciation charges in later years reflects the reality of an asset's changing
economic usefulness over time.

n
Sum of the year’s digit, SUM = 2 (1+ n)
n - m +1
Annual depreciation, d = (FC - SV )
SUM
m(2n - m +1)
Total depreciation after m years, Dm = (FC - SV )
2(SUM )
Book Value, BVm = FC - Dm

Year Year in Depreciation Depreciation during

reverse order factor the year
1 3 (3/6) (FC - SV)(3/6)
2 2 (2/6) (FC - SV)(2/6)
3 1 (1/6) (FC - SV)(1/6)
Sum = 6

Example: The corporation purchased a machine for P1 million. Freight and installation charge
amounted to 3% of the purchase price. If the machine shall be depreciated over a period
of 8 years with a salvage value of 12%. (a) Determine the depreciation charged during
the 5th year using sum of the year digit method. (b) Determine the book value at the end
of each year

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Solution:
FC = P1 M + (0.03)(P1 M) = P1.03 M
SV = 0.12(P1.03 M) = P123,600
n = 8, m = 5
d=?

n
SUM = 2 (1+ n) = = 36
n - m +1 8 8 - 5 +1
d = (FC - SV ) = (1+ 8) (P1.03M - P126,000)
SUM236
d = P100,711.11

FC - SV =P1.03 M - P123,600 = P906,400

Value before Value after

Year Depreciation
depreciation depreciation
æ8ö
1 P1,030,000 ç ÷ (906,400) = P201,422.22 P828,577.78
è 36 ø
æ7ö
2 P828,577.78 ç ÷ (906,400) = P176,244.44 P652,333.34
è 36 ø
æ 6 ö
3 P652,333.34 ç ÷ (906,400) = P151,066.67 P501,266.67
è 36 ø
æ 5 ö
4 P501,266.67 ç ÷ (906,400) = P125,888.89 P375,377.78
è 36 ø
æ 4 ö
5 P375,377.78 ç ÷ (906,400) = P100,711.11 P274,666.67
è 36 ø
æ 3 ö
6 P274,666.67 ç ÷ (906,400) = P75,533.33 P199,133.33
è 36 ø
æ 2 ö
7 P199,133.33 ç ÷ (906,400) = P50,355.56 P148,777.78
è 36 ø
æ1 ö
8 P148,777.78 ç ÷ (906,400) = P25,177.78 P123,600
è 36 ø
Sum = 36

Example: An asset is purchased for P9,000 its estimated life is 10 years, after which it will be sold
for P1,000 find the book value during the third year if the sum of the year digit
depreciation is used.

Solution:
FC = P9,000, SV = P1,000

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n = 10, m = 3,
BV3= ?

BV = FC - Dm
SUM = n (1+ n) = 10 (1+10) = 55
2 2
Dm = (FC - SV ) m(2n - m +1) = (P9,000 - P1,000) 3[2(10)-3 +1]
2(SUM ) 2(55)
Dm = P3,927.27
BV = FC - Dm = P9,0000 - P3.927.27

BV = P5,072.73

DECLINING BALANCE METHOD

The declining balance method (constant percentage) method is an accelerated depreciation system
of recording larger depreciation expenses during the earlier years of an asset’s useful life and recording
smaller depreciation expenses during the asset's later years.

The declining balance method, is ideal for assets that quickly lose their values or inevitably become
obsolete. This is classically true with computer equipment, cell phones, and other high-tech items, which
are generally useful earlier on but become less so as newer models are brought to market. An accelerated
method of depreciation ultimately factors in the phase-out of these assets.

The declining balance technique represents the opposite of the straight -line depreciation method,
which is more suitable for assets whose book value drops at a steady rate throughout their useful lives.
This method simply subtracts the salvage value from the cost of the asset, which is then divided by the
useful life of the asset. So, if a company shells out P150,000 for a truck with a P50,000 salvage value and
a useful life of five years, the annual straight-line depreciation expense equals P20,000 (P150,000 minus
50,000 divided by five).

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This method is based on the compound interest formula F = P (1 + i)n, where P is the First
cost(FC), F is the book value at any time, and i is the depreciation rate and is equal to K, Then;

BVm = FC (1 – K)m
Constant percentage, K = 1- n SV , SV = FC (1 - K)n
FC y

Year Book Value at Deprecation during the Book value at the end
beginning of the year year of the year
1 FC d1 = kFC0 BV1 = FC0 - d1
2 FC (1- k ) d = kFC BV = FC - d
2 1 2 1 2

3 FC (1 - k )2 d2 = kFC2 BV3 = FC2 - d3

…
n FC (1 - k )n d2 = kFCn BVn = FCn-1 - dn
Example: A certain office equipment has a first cost of P20,000 and a salvage value of P1,000 at
the end of 10 years. Determine the salvage value at the end of 6 years using declining
balance method

Solution:
FC = P20,000, SV = P1,000
n = 10, m=6
BV6= ?

SV 1,000
K = 1- n =1- 10 = 0.2589
FC 20,000

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BVm = FC (1 – K)m = P20,000 (1 - 0.25887)6

BV = P3,314.45

Example: Determine the rate of deprecation, the total depreciation up to the end of 8th year and the
book value at the end of 8 years for an asset that cost P15,000 new has an estimated
scrap value of P2,000 at the end of 10 years using constant percentage method

Solution:
FC = P15,000 SV = P2,000
m = 8, n = 10
K = ?, Dm = ? BV = ?

K = 1- n SV =1- 10 2,000
FC 15,000
K = 18.25%

BV8 = P15,000(1 - 0.1825)8

BV8 = P2,992.22

BV = FC - Dm
D8 = FC -BV
D8 = P15,000 - P2,992.22
D8 = P12,007.78

DOUBLE DECLINING BALANCE METHOD

The double declining balance depreciation (DDB) method, also known as the reducing balance method,
is one of two common methods a business uses to account for the expense of a long-lived asset. The double
declining balance depreciation method is an accelerated depreciation method that counts as an expense more
rapidly (when compared to straight-line depreciation that uses the same amount of depreciation each year over
an asset's useful life). Similarly, compared to the
standard declining balance method, the double declining method depreciates assets twice as quickly.

The double declining balance method is a type of declining balance method with a double
depreciation rate. The declining balance method is one of the two accelerated depreciation methods, and
it uses a depreciation rate that is some multiple of the straight-line method rate.

Depreciation rates used in the declining balance method could be 150%, 200% (double), or 250%
of the straight-line rate. When the depreciation rate for the declining balance method is set as a multiple
doubling the straight-line rate, the declining balance method is effectively the double declining balance

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method. Over the depreciation process, the double depreciation rate remains constant and is applied to
the reducing book value each depreciation period.

The book value, or depreciation base, of an asset declines over time. With the constant double
depreciation rate and a successively lower depreciation base, charges calculated with this method
continually drop. The balance of the book value is eventually reduced to the asset's salvage value after
the last depreciation period. However, the final depreciation charge may have to be limited to a lesser
amount to keep the salvage value as estimated.

Declining Depreciation vs. the Double-Declining Method

If a company often recognizes large gains on sales of its assets, this may signal that it's using
accelerated depreciation methods, such as the double-declining balance depreciation method. Net income
will be lower for many years, but because book value ends up being lower than market value, this ultimately
leads to a bigger gain when the asset is sold. If this asset is still valuable, its sale could portray a misleading
picture of the company's underlying health.
!
Depreciation charge to date = " x BV at the start of year

BVm = FC !1 − "! %# ≥ SV!

d = " BVm
Example: A radio service panel truck initially cost P56,000. Its resale value at the end of the 5th year
of the useful life is estimated at P15,000. By means of double declining balance method,
determine the total depreciation for the 2nd year.

Solution:
FC = P 56,000 SV = P15,0000
n = 5, m=2
D2=?

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BVm = FC !1 − "! %#

2
BV2 = P56,000(1 - 5 )2
BV2 = P20,160
D2 = P56,000 - P20,160

D2 = P35,840

Activity: Skill-building Activities

Answer the following questions.

1. A company purchases an asset for the P10,000 and plans to keep it for 20 years. If the salvage
value is zero at the end of 20th year, what is the book value in the third year? Use SOYD method
2. A machine purchased for P150,000 its estimated life is 15 years, after which it will be sold for
P40,000 find the book value during the 6th year if the sum of the year digit depreciation is used.
3. A certain office equipment has a first cost of P20,000 and a salvage value of P1,000 at the end
of 10 years. Determine the book value at the end of 6 years using double declining balance
method

4. A machine having a first cost of P60,000 will be retired at the end of 8 years. Depreciation cost
is computed using constant percentage of the declining book value. What is the total cost of
depreciation, in pesos, up to time the machine is retired if the annual rate of depreciation is
28.72%?

5. A machine has a first cost of P200,000 with a salvage value of P25,000 at the end of economic
life of 10 years. Find its book value after 8 years using the Double Declining Balance Method.

Activity: Check for Understanding

Solve the following problems.

1. A machine is bought at P420,000 with an economic life of 6 years and a salvage value
of P50,000. The cost of money is 12% per year. If the first-year depreciation is
P105,714, what method of deprecation was used?

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2. A machine is bought at P420,000 with an economic life of 6 years and a salvage value
of P50,000. The cost of money is 12% per year. If the first-year depreciation is
P105,714, what method of deprecation was used?
3. A certain machine has a initial cost of 50,000 and a book a value of 15,811.39 after five years.
Find the salvage value of the machine if has an economic life of 10 years

C. LESSON WRAP-UP

Think about your Learning

1. What motivated you to finish the lesson today?

________________________________________________________________________
________________________________________________________________________

2. What could you have done better to improve your learning today?
_________________________________________________________________________
_________________________________________________________________________

KEY TO CORRECTIONS

Activity 3

1. P7,285.71
2. P81,250
3. P5,242.88
4. P56,001.549
5. P33,554.43

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 ECO 017: Engineering Economics
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Name:_________________________________________________________ Class number: _____

Section: ____________ Schedule: ________________________________ Date: ______________

Lesson Title: BREAK-EVEN ANALYSIS Materials: Ballpoint, Notebook,

Learning Targets: Calculator
At the end of the module, you should be able to: Text book: Engineering Economy
1. Define Break-even analysis by Hipolito B. Sta. Maria, 3rd Ed
2. Define the nature and importance of References:
Break-even analysis 1. Engineering Mathematics vol 2
by Gillesania
2. Engineering Economy, Custom
Edition, by Niall M. Fraser,
et.al. Pearson Learning
Solutions. 2011
3. investopedia.com
4. https://cleartax.in/s/break-even-
analysis

A. LESSON PREVIEW/REVIEW
Introduction
There are economic concepts applied to the optimum design of engineering projects and operation of
production processes, like minimization of design cost and/or production costs, and production rate to
maximize profits. At the operations level, optimum means maximization of production for a given level of
production cost or minimization of production cost for a given level of production.

B. MAIN LESSON

Content Notes

BREAK-EVEN ANALYSIS

A break-even analysis involves the determination of the value of a specified variable that will make the
revenues exactly equal to the costs - i.e. break-even. This technique can be used for one project or for
determining the best of two or more alternatives. The basic technique involves identifying the variable of
interest and then finding the magnitude of that variable that will lead to break-even. Once the break-even point
is known, the available information about whether that variable is likely to have a value above or below the
break-even point can be used to determine which course of action should be taken. The next example
illustrates a break-even calculation.

Break-even analysis is useful in the determination of the level of production or a targeted desired sales
mix. The study is for management’s use only, as the metric and calculations are not necessary for external
sources such as investors, regulators or financial institutions. This type of analysis depends on a calculation
of the break-even point (BEP). The break-even point is calculated by dividing the total fixed costs of production

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by the price of a product per individual unit less the variable costs of production. Fixed costs are those which
remain the same regardless of how many units are sold.

Break-even analysis looks at the level of fixed costs relative to the profit earned by each additional unit
produced and sold. In general, a company with lower fixed costs will have a lower break-even point of sale.
For example, a company with $0 of fixed costs will automatically have broken even upon the sale of the first
product assuming variable costs do not exceed sales revenue. However, the accumulation of variable costs
will limit the leverage of the company as these expenses come from each item sold.

Components of Break-even Analysis

1. Fixed Costs

Fixed costs are also called overhead costs. These overhead costs occur after the decision to start
an economic activity is taken and these costs are directly related to the level of production, but not the
quantity of production. Fixed costs include (but are not limited to) interest, taxes, salaries, rent,
depreciation costs, labour costs, energy costs etc. These costs are fixed rrespective of the production. In
case of no production also the costs must be incurred.

2. Variable Costs

Variable costs are costs that will increase or decrease in direct relation to the production volume.
These costs include cost of raw material, packaging cost, fuel and other costs that are directly related to
the production.

3. Contribution Margin
Break-even analysis also deals with the contribution margin of a product. The excess between the
selling price and total variable costs is known as contribution margin. For an example, if the price of a
product is P100, total variable costs are P60 per product and fixed cost is P25 per product, the contribution

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margin of the product is P40 (P100 – P60). This P40 represents the revenue collected to cover the fixed
costs. In the calculation of the contribution margin, fixed costs are not considered.

When is Break even analysis used?

▪ Starting a new business: To start a new business, a break-even analysis is a must. Not only it helps
in deciding whether the idea of starting a new business is viable, but it will force the startup to be
realistic about the costs, as well as provide a basis for the pricing strategy.

▪ Creating a new product: In the case of an existing business, the company should still peform a
break-even analysis before launching a new product—particularly if such a product is going to add a
significant expenditure.

▪ Changing the business model: If the company is about to the change the business model, like,
switching from wholesale business to retail business, then a break-even analysis must be performed.
The costs could change considerably and breakeven analysis will help in setting the selling price.

Break-even analysis is useful for the following reasons:

▪ It helps to determine remaining/unused capacity of the company once the breakeven is reached. This
will help to show the maximum profit on a particular product/service that can be generated.
▪ It helps to determine the impact on profit on changing to automation from manual (a fixed cost
replaces a variable cost).
▪ It helps to determine the change in profits if the price of a product is altered.
▪ It helps to determine the amount of losses that could be sustained if there is a sales downturn.

Additionally, break-even analysis is very useful for knowing the overall ability of a business to
generate a profit. In the case of a company whose break-even point is near to the maximum sales level,
this signifies that it is nearly impractical for the business to earn a profit even under the best of
circumstances.

Therefore, it’s the management responsibility to monitor the break-even point constantly. This
monitoring certainly reduces the break-even point whenever possible.

Ways to Monitor Break-even Point

▪ Pricing analysis: Minimize or eliminate the use of coupons or other price reductions offers, since such
promotional strategies increase the break-even point.

▪ Technology analysis: Implementing any technology that can enhance the business efficiency, thus
increasing capacity with no extra cost.

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▪ Cost analysis: Reviewing all fixed costs constantly to verify if any can be eliminated can surely help.
Also, review the total variable costs to see if they can be eliminated. This analysis will increase the
margin and reduce the breakeven point.

▪ Margin analysis: Push sales of the highest-margin (high contribution earning) items and pay close
attention to product margins, thus reducing the breakeven point.

▪ Outsourcing: If an activity consists of a fixed cost, try to outsource such activity (whenever possible),
which reduces the breakeven point.

Benefits of Break-even Analysis

▪ Catch missing expenses: When you’re thinking about a new business, it’s very much possible that you
may forget about a few expenses. Therefore, a break-even analysis can help you to review all financial
commitments to figure out your break-even point. This analysis certainly restricts the number of surprises
down the road or atleast prepares a company for them.

▪ Set revenue targets: Once the break-even analysis is complete, you will get to know how much you
need to sell to be profitable. This will help you and your sales team to set more concrete sales goals.

▪ Make smarter decisions: Entrepreneurs often take decisions in relation to their business based on
emotion. Emotion is important i.e. how you feel, though it’s not enough. In order to be a successful
entrepreneur, decisions should be based on facts.

▪ Fund your business: This analysis is a key component in any business plan. It’s generally a
requirement if you want outsiders to fund your business. In order to fund your business, you have to
prove that your plan is viable. Furthermore, if the analysis looks good, you will be comfortable enough
to take the burden of various ways of financing.

▪ Better Pricing: Finding the break-even point will help in pricing the products better. This tool is highly
used for providing the best price of a product that can fetch maximum profit without increasing the
existing price.

▪ Cover fixed costs: Doing a break-even analysis helps in covering all fixed cost.

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Activity: Skill-building Activities

Answer the following questions.

1. When a business has made enough money to pay its costs and begin to make a profit, it
has reached its?

2. Fixed Expenses do not change in total when there is a modest change in sales.
(True or False)

3. Situation:

Selling Price: P 1,700

Fixed expenses
Selling and administrative P 13,000,000
Interest and expenses P 1,000,000

Fixed expenses
Selling and administrative P 300
Cost of goods sold P 400

Requirement: What is the company’s contribution margin?

Activity: Check for Understanding

True or False

1. If a company has mixed expenses, the fixed component can be combined with the
company's fixed expenses and the variable component can be combined with the
company's variable expenses.

2. The contribution margin per unit is the selling price per unit minus the fixed expenses per
unit.

3. Break-even analysis is useful for companies that sell products, but it is not useful for
companies that provide services.

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C. LESSON WRAP-UP

Thinking about Learning

1. What motivated you to finish the lesson today?
________________________________________________________________________
________________________________________________________________________

2. What could you have done better to improve your learning today?
_________________________________________________________________________
_________________________________________________________________________

KEY TO CORRECTIONS

Activity: Skill-building Activities

1. Break-even point
2. True
3. P 1000

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Name:_________________________________________________________ Class number: _____

Section: ____________ Schedule: ________________________________ Date: ______________

Lesson Title: MATHEMATICAL EXPRESSION FOR Materials:

BREAK-EVEN Ballpoint, Notebook, Calculator
Learning Targets:
At the end of the module, you should be able to: References:
1. Solve break-even problems using mathematical expression Engineering Economy by Hipolito
B. Sta. Maria, 3rd Ed
Engineering Mathematics vol 2 by
Gillesania
https://www.businessmanagementi
deas.com/

A. LESSON PREVIEW/REVIEW

Break even analysis or cost analysis is concerned with finding the point at which revenues and costs are
exactly equal. This point is known as BREAK-EVEN-POINT. Hence, this is a volume of output at which
neither a profit is made nor a loss is incurred. There-fore production or sale must not be allowed to fall beyond
this point. This analysis can be carried out either algebraically or graphically.

This technique can be used for one project or for determining the best of two or more alternatives. The basic
technique involves identifying the variable of interest and then finding the magnitude of that variable that will
lead to breakeven. Once the breakeven point is known, the available information about whether that variable
is likely to have a value above or below the breakeven point can be used to determine which course of action
should be taken.

B. MAIN LESSON

Content Notes

Calculation for Break-Even Analysis

𝑹 = 𝒑𝑵
𝑪 = 𝒇 + 𝒂𝑵

𝑓 = 𝐹𝑖𝑥𝑒𝑑 𝐶𝑜𝑠𝑡
𝑎 = 𝑎𝑛 𝑖𝑛𝑐𝑟𝑒𝑚𝑒𝑛𝑡𝑎𝑙 𝑐𝑜𝑠𝑡 𝑤ℎ𝑖𝑐ℎ 𝑖𝑠 𝑡ℎ𝑒 𝑐𝑜𝑠𝑡 𝑡𝑜 𝑝𝑟𝑜𝑑𝑢𝑐𝑒 𝑜𝑛𝑒 𝑎𝑑𝑑𝑖𝑡𝑖𝑜𝑛𝑎𝑙 𝑖𝑡𝑒𝑚
= 𝑚𝑎𝑟𝑔𝑖𝑛𝑎𝑙 𝑐𝑜𝑠𝑡 𝑜𝑟 𝑣𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝑐𝑜𝑠𝑡

𝑅 = 𝑇𝑜𝑡𝑎𝑙 𝑅𝑒𝑣𝑒𝑛𝑢𝑒
𝑝 = 𝑖𝑛𝑐𝑟𝑒𝑚𝑒𝑛𝑡𝑎𝑙 𝑟𝑒𝑣𝑒𝑛𝑢𝑒, 𝑟𝑒𝑣𝑒𝑛𝑢𝑒 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡, 𝑜𝑟 𝑡ℎ𝑒 𝑠𝑒𝑙𝑙𝑖𝑛𝑔 𝑝𝑟𝑖𝑐𝑒 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡
𝑁 = 𝑏𝑟𝑒𝑎𝑘 − 𝑒𝑣𝑒𝑛 𝑝𝑜𝑖𝑛𝑡 𝑜𝑟 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑝𝑟𝑜𝑑𝑢𝑐𝑒𝑑 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡
𝐶 = 𝑇𝑜𝑡𝑎𝑙 𝑐𝑜𝑠𝑡

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Assuming there is no change in inventory, the break-even point can be found from

𝑪 = 𝑹
𝑓 + 𝑎𝑁 = 𝑝𝑁
𝒇
𝑵 =
𝒑−𝒂

ELEMENTS AND FORMULA

Break Even Chart

Break-even chart is a graphical representation of break-even analysis. The break-even point is the
quantity of production at which the income is equal to total cost. It is the intersection of the income line and the
total cost line on the break-even chart

When two alternatives are to be compared, the break-even point is the intersection of the total cost line
for each alternative on the break-even chart.

Example 1: Colin is the managerial accountant in charge of Company A, which sells water bottles. He
previously determined that the fixed costs of Company A consist of property taxes, a lease, and
executive salaries, which add up to $100,000. The variable cost associated with producing one water
bottle is $2 per unit. The water bottle is sold at a premium price of $12. Determine the break-even point
of Company A’s premium water bottle:

Solution:
f = $100,000
a = $2
p = $12
𝒇
Using the formula: 𝑵 = 𝒑−𝒂
𝑵 = 10,000 bottles

Therefore, given the fixed cost, variable cost and selling price of the water bottles, Company A would
need to sell 10,000 units of water bottles to break-even.

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Graphically Representing the Break Even Point

The graphical representation of unit sales and dollar sales needed to break even is referred to as the break-
even chart or Cost Volume Profit (CVP) graph. Below is the CVP graph of the example above:

Explanation:
• The number of units is on the X-axis (horizontal) and the dollar amount is on the Y-axis
(vertical).
• The red line represents the total fixed costs of $100,000.
• The blue line represents revenue per unit sold. For example, selling 10,000 units would
generate 10,000 x $12 = $120,000 in revenue.
• The yellow line represents total costs (fixed and variable costs). For example, if the company
sells 0 units, then the company would incur $0 in variable costs but $100,000 in fixed costs for
total costs of $100,000. If the company sells 10,000 units, the company would incur 10,000 x $2
= $20,000 in variable costs and $100,000 in fixed costs for total costs of $120,000.
• The break-even point is at 10,000 units. At this point, revenue would be 10,000 x $12 =
$120,000 and costs would be 10,000 x 2 = $20,000 in variable costs and $100,000 in fixed
costs.
• When the number of units exceeds 10,000, the company would be making a profit on the units
sold. Note that the blue revenue line is greater than the yellow total costs line after 10,000 units
are produced. Likewise, if the number of units is below 10,000, the company would be incurring
a loss. From 0-9,999 units, the total costs line is above the revenue line.

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Example 2: The cost of producing a small transistor radio set consists of P 23 for labor and P 37 for
materials. The fixed charge in operating the plant are P 100,000 per month. The variable
cost is P 1 per set. The radio set can be sold for P 75 each. Determine how many sets
must be produced per month to break-even.
Solution:
Total income = P75 𝑵
Total cost = P 100,000 + (P 23 + P 37 + P 1) 𝑵 = P 100,000 + P 61(x)

To break-even total cost must be equal to total income/revenue

P 75 𝑵 = P 100,000 + P 61 𝑵
P 75 𝑵 – P 61 𝑵 = P 100,000
P 14 𝑵 = P 100,000
𝑵 = 7142.86 = 7,143 sets

Example 3: A company has a production capacity of 500 unit per month and its fixed cost are P250,000
a month. The variable cost per unit is P 1,150 and each unit can be sold for P2,000.
Economy measures instituted to reduce the fixed cost by 10 percent and the variable cost
by 20 percent. Determine the old and new break-even points. What are the old and new
profit at 100 percent capacity?
Solution:

For Old or original Set-up:

Revenue: P 2,000 per unit

Old fixed cost: P 250,000 per month
Old variable cost: P 1,150 per unit

Total cost = Total Revenue

𝑪 = 𝑹
P 250,000 + P 1,150 𝑵 = P 2,000 𝑵
𝑵𝒐𝒍𝒅 = 294.12 = 294 units

Old profit = Total Revenue – Total Expenses

= P 2,000(500) – P 225,000 – P 920(500)
= P315,000 per month

For New Set-up:

New fixed costs: P 250,000(0.90) = P 225,000

New variable costs: P 1,150(0.80) = P 920 per unit

𝑪 = 𝑹
P 2,000NNew = P225,000 + P920 𝑵𝒏𝒆𝒘
𝑵𝒏𝒆𝒘 = 208 units

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New profit = Total Revenue – Total Expenses

= P 2,000(500) – P 225,000 – P 920(500)
= P315,000 per month

Activity: Skill-building Activities

IT’S TIME TO APPLY WHAT YOU LEARN. TRY TO

SOLVE THE GIVEN PROBLEMS.

1. Determine the break-even point in terms of number of units produced

per month using the following data:
Selling price = P600 per unit
Total overhead expenses = P428,000 per month
Labor cost = P115 per unit
Cost of materials = P76 per unit
Other variable cost = P2.32 per unit

2. Compute for the number of blocks that an ice plant must be able to sell per month to break-even
based on the following data:
Cost of electricity paid per block = P20
Tax to be paid per block = P2
Real state tax = P3,500 per month
Salaries and wages = P25,000 per month
Others = P12,000 per month
Selling price = 55 per block

Activity: Check for Understanding

A local company assembling stereo radio cassette produces 300 units per month at a cost of P800 per
unit. Each stereo radio cassette sells for P1,200. If the firm makes a profit of 10% on its 10,000 shares
with a par value of P200 per share, and fixed cost are P20,000 per month
a. What is the break-even point?
b. How much is the loss or profit if only 100 units are produced in a given month

ATTACH ADDITIONAL SHEETS OF PAPER FOR YOUR SOLUTIONS!

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C.LESSON WRAP-UP

Thinking about Learning

Three things you learned:

1. _____________________________________________________________________________________

2. _____________________________________________________________________________________

3. _____________________________________________________________________________________

Two things that you would like to learn more about:

1. _____________________________________________________________________________________

2. _____________________________________________________________________________________

One question you still have:

1. ____________________________

KEY TO CORRECTIONS

Skill-building Activities
1. 1,053 units
2. 1,288 blocks 1,288 blocks

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