ENGINEERING ECONOMY Example 1: Determine the ordinary simple interest on P 20,000

for 9 months and 10 days if the rate of interest is 12%.

Engineering Economy – 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 ensure the best use of capital.
SET 1A: INTEREST AND MONEY-TIME RELATIONSHIPS
Interest – is the amount of money paid for the use of borrowed
capital (borrower’s viewpoint) or the income produced by
money which has been loaned (lender’s viewpoint).
𝐹 =𝑃+𝐼
Where:
I = interest
P = principal or present worth
F = accumulated amount or future worth
Cash-Flow Diagrams
Cash-Flow Diagram – is a graphical representation of cash flows
drawn on a time scale.
↑ - receipt (positive cash flow or cash inflow)
↓ - disbursement (negative cash flow or cash outflow)
Example: A loan of P100 at simple interest will becomeP150
after 5 years.
Cash flow diagram on the viewpoint of the lender
Ans. P 1,866.67
Example 2: Determine the (a) ordinary and (b) exact simple
interests on P 100,000 for the period January 15 to June 20
2012 if interest is 15%.
Ans. (a) P 6,541.67; (b) P 6434.43
Example 3: Calculated the exact interest on an investment of P
2,000.00 for a period from January 30 to September 15, 2001 if
the rate of interest is 10%.
Ans. P124.93
Example 4: If P 4000 is borrowed for 75 days at 16% per annum.
How much will be due at the end of 75 days?
Ans. P 4,133.33
Example 5: How long will it take for a deposit of P 1, 500.00 to
earn P 186 if invested at the simple interest rate of 7 1/3%?
Ans. 1.6909 years
Example 6: If you borrow money from your friend with simple
interest of 12%, find the present worth of P 20,000 at the end of
9 months.
Ans. P 18,348.60
Example 7: (CE Board) A deposit of P 110,000 was made for 31
days. The net interest after deducting 20% withholding tax is P
890.36. Find the rate of return annually.
Ans. 11.75%
Example 8: A man buys an electric fan from a merchant that
charges P1500.00 at the end of 90 days. The man wishes to pay
cash. What is the cash price if money is worth 10% simple
interest?
Ans. P 1,463.41
Example 9: What amount will be available in eight months if P
15,000.00 is invested now at 10% simple interest per year?
Ans. P 16,000.00
Example 10: P 1000.00 becomes P 1500.00 in three years. Find
the simple interest rate.
Ans. 16.67%
Example 11: An engineer borrowed a sum of money under the
following terms: P 650,000.00 if paid in 90 days, or P 600,000.00
if paid in 30 days. What is the equivalent annual rate of simple
interest?
Ans. 50%

Compound Interest
Compound Interest – the interest for an interest period is
calculated on the principal plus total amount of interest
Cash flow diagram on the viewpoint of the borrower accumulated in previous period.

Simple Interest
Simple Interest – is calculated using the principal only, ignoring
any interest that has been accrued in preceding periods.
𝐼 = 𝑃𝑛𝑖

𝐹 = 𝑃(1 + 𝑖𝑛)

Where:
I = interest Principal at
P = principal or present worth Interest Interest Earned Amount at End
Beginning
n = number of interest periods Period During Period of Period
of Period
i = rate of interest per period 1 P Pi P(1+i)
F = accumulated amount or future worth
2 P(1+i) P(1+i)i P(1+i)2
For Ordinary Simple Interest:
Interest period = 1 year = 360 days 3 P(1+i)2 P(1+i)2i P(1+i)3
For Exact Simple Interest: … … … …
Interest period = 1 year = 365 days (ordinary year)
n P(1+i)n-1 P(1+i)n-1i P(1+i)n
= 366 days (leap year)
𝐹 = 𝑃(1 + 𝑖)𝑛
SAMPLE PROBLEMS
 𝐹 𝐹 Example 6: If money is worth 5% compounded quarterly, find
= (1 + 𝑖)𝑛 = ( , 𝑖%, 𝑛)
𝑃 𝑃 the equated time for paying a loan of P 150,000 due in one year
and P 280,000 in 2 years.
𝑃 = 𝐹(1 + 𝑖)−𝑛
Ans. 1.6455 years
𝑃 𝑃 Example 7: Five years ago, you paid P 340,000 for a lot. Today
= (1 + 𝑖)−𝑛 = ( , 𝑖%, 𝑛) you sold it at P 500,000. What is the annual rate of appreciation?
𝐹 𝐹
Ans. 8%
Where: Example 8: John borrowed P50, 000.00 from the bank at 25%
F = accumulated amount or future worth compounded semi-annually. What is the equivalent effective rate
P = principal or present worth of interest?
i = rate of interest per interest period Ans. 26.56%
n = number of compounding periods Example 9: Find the present worth of a future payment of P
F/P = single payment compound amount factor 300,000 to be made 5 years with an interest rate of 8% per
P/F = single payment present worth factor annum.
Ans. P 204,174.96
Nominal Rate of Interest – specifies the rate of interest and the Example 10: How long will it take money to double itself if
number of interest periods in one year. invested at 5% compounded annually?
𝑟
𝑖= Ans. 14.2 years
𝑚 Example 11: The amount of P 50,000 was deposit in the bank
𝑛 = 𝑚𝑦 earning an interest of 7.5% per annum. Determine the total
amount at the end of 5 years, if the principal and interest were
𝑟 𝑚𝑦 not withdrawn during the period?
𝐹 = 𝑃 (1 + )
𝑚 Ans. P 71,781.47
Example 12: Compute the equivalent rate of 6% compounded
semi-annually to a rate compounded quarterly.
Where:
Ans. 5.96% compounded quarterly
i = rate of interest per interest period
Example 13: If P5, 000.00 shall accumulate for 10 years at 8%
n = number of compounding periods
compounded quarterly. Find the compounded interest at the end
r = nominal rate of interest
of 10 years.
m = number of compounding periods per year
Ans. P 6,040.20
y = number of years
Example 14: A sum of P 1,000.00 is invested now and left for
eight years, at which time the principal is withdrawn. The
Compounding Period m
interest has accrued is left for another eight years. If the effective
Compounded Quarterly 4
annual interest rate is 5%, what will be the withdrawal amount
Compounded Semi-annually 2
at the end of the 16th year?
Compounded Monthly 12
Compounded Bi-monthly 6 Ans. P 705.42
Example 15: By the condition of a will, the sum of P 2,000 is left
Effective Rate of Interest – is the actual or exact rate of interest on to a girl to be held in trust fund by her guardian until it amounts
the principal during 1 year, or simply the ratio of accumulated to P 5,000, when will the girl received the money if the fund is
interest in one year to the principal amount. invested at 8% compounded quarterly?
𝐹−𝑃 Ans. 11.57 years
𝐸𝑅 = Example 16: A student plan to deposit P1, 500 in the bank now
𝑃
and another P3, 000 for the next 2 years. If he plans to withdraw
𝑟 𝑚 P5, 000 3 years after his last deposit for the purpose of buying
𝐸𝑅 = (1 + 𝑖)𝑚 − 1 = (1 + ) −1
𝑚 shoes, what will be the amount of money left in the bank after
one year of his withdrawal? Effective annual interest rate is 10%.
Ans. P 1,549.64
SAMPLE PROBLEMS
Example 17: If the interest rate of a certain account is 6.5%,
Example 1: The amount of P 20,000 was deposited in a bank
compute the (a) single payment present worth factor; and (b)
earning an interest rate of 6.5% per annum. Determine the total
single payment compound amount factor at the end of 18 years.
amount at the end of 7 years if the principal and interest were
Ans. (a) 0.322; (b) 3.107
not withdrawn during this period.
Ans. P 31,079.73
Continuous Compounding Interest
Example 2: A man expects to receive P 25,000 in 8 years. How
From the compound interest formula for m periods per year:
much is that money worth now considering interest at 8%
𝑟 𝑚𝑦
compounded quarterly? 𝐹 = 𝑃 (1 + )
𝑚
Ans. P 13,265.83
Example 3: How many years will P 100,000 earn a compounded Let
𝑚
= 𝑘, then 𝑚 = 𝑟𝑘, as m increases, so must k:
𝑟
interest of P 50,000 if interest is 9% compounded quarterly? 𝑟𝑦
Ans. 4.56 years 𝑟 𝑚𝑦 1 𝑟𝑘𝑦 1 𝑘
(1 + ) = (1 + ) = [(1 + ) ]
Example 4: Find the effective rate of interest corresponding to 𝑚 𝑘 𝑘
8% compounded quarterly.
1 𝑘
Ans. 8.24% The limit of (1 + ) as k approaches infinity is e, thus:
𝑘
Example 5: Find the nominal rate, which if converted quarterly 𝐹 = 𝑃𝑒 𝑟𝑦
could be used instead of 12% compounded semiannually?
Ans. 11.825% The effective rate of interest for continuous compounding is:
𝐸𝑅 = 𝑒 𝑟 − 1
Where: Where:
F = accumulated amount or future worth d = discount rate for the period involved
P = principal or present worth i = rate of interest for the same period
r = nominal rate of interest
y = number of years SAMPLE PROBLEMS
e = Euler’s number Example 1: Mr. T borrowed money from the bank. He receives
𝑒 𝑟𝑦 = continuous compound amount factor from the bank P 1,340 and promised to pay P 1,500 at the end of
1
= present worth of continuous compounding factor 9 months. Compute: (a) Simple interest rate; and (b) Discount
𝑒 𝑟𝑦
Rate.
Ans. (a) 15.92%; (b) 13.73%
SAMPLE PROBLEMS
Example 2: Find the discount if P 2,000 is discounted for 6
Example 1: P 100,000 is deposited in a bank that earns 5%
months at 8% simple discount.
compounded continuously. What will be the amount after 10
Ans. P 80
years?
Example 3: Discount 1650 for 4 months at 6% simple interest.
Ans. P 164,872.13
What is the discount?
Example 2: Money is deposited in a certain account for which
Ans. P 32.35
interest is compounded continuously. If the balance doubles in 6
years, what is the annual percentage rate?
Ans. 11.55%
Example 3: A man wishes to have P 40,000 in a certain fund at
Inflation
the end of 8 years. How much should he invest in a fund that will
Inflation – is the increase in the prices for goods and services
pay 6% compounded continuously?
from one year to another, thus decreasing the purchasing power
Ans. P 24, 751.34
of money.
Example 4: If the effective annual interest rate is 4%, compute
𝐹𝐶 = 𝑃𝐶(1 + 𝑓)𝑛
the equivalent nominal interest compounded continuously.
Ans. 3.922% Where:
Example 5: What is the nominal rate of interest compounded FC = future cost of a commodity
continuously for 10 years if the compound amount factor is PC = present cost of a commodity
1.34986? f = annual inflation rate
Ans. 3% n = number of years
Example 6: Deposits of P35,000.00, P48,000.00 and P25,000.00 In an inflationary economy, the buying power of money
were made in a savings account eight years, five years, and two decreases as cost increases:
years ago, respectively. Determine the accumulate amount in the 𝑃
account today if a withdrawal of P55,000.00 was made four years 𝐹=
(1 + 𝑓)𝑛
ago. The applied interest rate is 11% compounded continuously.
Ans. P 113,330.66 If interest is computed as the same time that inflation is
occurring:
Discount 1+𝑖 𝑛
Discount – is the difference between the future worth of a certain 𝐹 = 𝑃( )
1+𝑓
commodity and its present worth.
2 Types of Discount: Where:
Trade Discount – discount offered by the seller to induce trading. F = future worth of today’s present amount P
Cash Discount – is the reduction on the selling price offered to a f = annual inflation rate
buyer to induce him to pay promptly. n = number of years
𝐷 =𝐹−𝑃 i = rate of interest
If the uninflated present worth is to be determined:
Where: 𝐹 𝐹
D = amount of discount 𝑃= =
(1 + 𝑖)𝑛 (1 + 𝑓)𝑛 (1 + 𝑖𝑐𝑓 )𝑛
F = accumulated amount or future worth
P = principal or present worth 𝑖𝑐𝑓 = 𝑖 + 𝑓 + 𝑖𝑓
Discount Rate – is the discount on one unit of principal per unit of
time. SAMPLE PROBLEMS
𝐹−𝑃 Example 1: A man invested P 130,000 at an interest rate of 10%
𝑑= = 1 − (1 + 𝑖)−1
𝐹 compounded annually. What will be the final amount of his
investment, in terms of today’s peso, after 5 years, if inflation
If the commodity is discounted in a certain period of time: remains the same at the rate of 8% per year?
𝐹𝑑 = 𝐹 − 𝑃 Ans. P 142,491
𝑃 = 𝐹(1 − 𝑑) 𝐹𝑜𝑟 1 𝑦𝑒𝑎𝑟 Example 2: What is the uninflated present worth of a P 200,000
future value in two years if the average inflation rate is 6% and
𝑃 = 𝐹(1 − 𝑛𝑑) For n years interest rate is 10%.
The relationship between discount rate and interest rate Ans. P 147,107
becomes:
𝑑
𝑖=
1−𝑑
and
𝑖
𝑑=
1+𝑖
SET 1B: ANNUITIES F = value or sum of money at some future time
Annuity – is a series of equal payments occurring at equal periods A = series of periodic equal amount of payments
of time. i = interest rate per interest period
n = number of interest periods/number of equal payments
Ordinary Annuity F/A = uniform series compound amount factor
Ordinary Annuity – a type of annuity were equal payments are A/F = sinking fund factor
made at the end of each period. SAMPLE PROBLEMS
Example 1: Find the annual payment to extinguish a debt of P
100,000 payable for 6 years at 12% interest annually.
Ans. P 24,322.57
Example 2: What annuity is required over 12 years to equate to a
future amount of P 200,000? i = 8%.
Ans. P 10,539.00
Example 3: A man paid 10% downpayment of P 200,000 for a
house and lot and agreed to pay the 90% balance on monthly
installment for 60 months at an interest rate of 15%
𝑃 = 𝐴(1 + 𝑖)−1 + 𝐴(1 + 𝑖)−2 + 𝐴(1 + 𝑖)−3 + ⋯ + 𝐴(1 + 𝑖)−(𝑛−1)
compounded monthly. Compute the amount of monthly
+ 𝐴(1 + 𝑖)−𝑛 → 𝐸𝑞. 1
payment.
Multiplying this equation by (1 + 𝑖), the equation becomes: Ans. P 42,821.87
𝑃 + 𝑃𝑖 = 𝐴 + 𝐴(1 + 𝑖)−1 + 𝐴(1 + 𝑖)−2 + ⋯ + 𝐴(1 + 𝑖)−𝑛+2 Example 4: Mr. Y bought a house and lot for $ 2,800,000 with a
+ 𝐴(1 + 𝑖)−𝑛+1 → 𝐸𝑞. 2 downpayment of $ 300,000. Interest is 5% to be paid for 30
years on a monthly basis. Compute the amount of monthly
Subtracting Eq. 1 from Eq. 2: payment.
𝑃𝑖 = 𝐴 − 𝐴(1 + 𝑖)−𝑛 Ans. $ 13,420.54
Example 5: A piece of machinery can be bought for P 10,000 cash,
𝐴 𝐴 (1 + 𝑖)𝑛 − 1
𝑃= [1 − (1 + 𝑖)−𝑛 ] = [ ] or for P 2,000 downpayment and payments of P 750 per year for
𝑖 𝑖 (1 + 𝑖)𝑛 15 years. What is the annual interest rate of the time payments?
(1 + 𝑖)𝑛 − 1 Ans. 4.6%
𝑃 𝑃
=[ ] = ( , 𝑖%, 𝑛) Example 6: A man inherited a regular endowment of P 100, 000
𝐴 𝑖(1 + 𝑖)𝑛 𝐴
every of 3 months for 10 years. However, he may choose to get a
The functional symbol (𝑃/𝐴, 𝑖%, 𝑛) is called the “uniform series single lump sum payment at the end of 4 years. How much is this
present worth factor”. lump sum if the cost of money is 14% compounded quarterly?
𝐴 𝑖(1 + 𝑖)𝑛 𝐴 Ans. P 3,702,939.73
=[ ] = ( , 𝑖%, 𝑛) Example 7: A service car whose cash price was P 540,000 was
𝑃 (1 + 𝑖)𝑛 − 1 𝑃
bought with a down payment of P 162,000 and monthly
The functional symbol (𝐴/𝑃, 𝑖%, 𝑛) is called the “capital recovery installment of P 10,874.29 for 5 years. What was the rate of
factor”. interest if compounded monthly?
Where: Ans. 24% compounded monthly
P = value or sum of money at present Example 8: If P500.00 is invested at the end of each year for 6
A = series of periodic equal amount of payments years, at an annual interest rate of 7%, what is the total peso
i = interest rate per interest period amount available upon the deposit of the sixth payment?
n = number of interest periods/number of equal payments Ans. P 3,576.65
P/A = uniform series present worth factor Example 9: A man purchased a car with a cash price of P 350,000.
A/P = capital recovery factor He was able to negotiate with the seller to allow him to pay only
Substituting 𝑃 = 𝐹(1 + 𝑖)−𝑛 from the equation of P, it becomes: a down payment of 20% and the balance payable in equal 48 end
𝐴 of the month installment at 1.5% interest per month. On the day
𝐹 = [(1 + 𝑖)𝑛 − 1] he paid the 20th installment, he decided to pay the remaining
𝑖
balance. How much is the monthly payment and what is the
remaining balance that he paid?
Ans. P 8,224.99; P 186,927.02
Example 10: For having been loyal, trustworthy and efficient, the
company has offered a superior a yearly gratuity pay of P
20,000.00 for 10 years with the first payment to be made one
year after his retirement. The supervisor, instead, requested that
he be paid a lump sum on the date of his retirement less interest
that the company would have earned if the gratuity is to be paid
on yearly basis. If interest is 15%, what is the equivalent lump
𝐹 (1 + 𝑖)𝑛 − 1 𝐹 sum that he could get?
=[ ] = ( , 𝑖%, 𝑛)
𝐴 𝑖 𝐴 Ans. P 100,375.37
Example 11: In anticipation of a much bigger volume of business
The functional symbol (𝐹/𝐴, 𝑖%, 𝑛) is called the “uniform series after 10 years, a fabrication company purchased an adjacent lot
compound amount factor”. for its expansion program where it hopes to put up a building
𝐴 𝑖 𝐴 projected to cost P 4,000,000.00 when it will be constructed 10
=[ ] = ( , 𝑖%, 𝑛)
𝐹 (1 + 𝑖)𝑛 − 1 𝐹 years after. To provide for the required capital expense, it plans
to put up a sinking fund for the purpose. How much must the
The functional symbol (𝐴/𝐹, 𝑖%, 𝑛) is called the “sinking fund
company deposit each year if interest to be earned is computed
factor”.
at 15%?
Where:
Ans. P 197,008.25 annual deposits
Example 12: A new office building was constructed 5 years ago
by a consulting engineering firm. At that time the firm obtained
the bank loan for P 10,000,000 with a 20% annual interest rate,
compounded quarterly. The terms of the loan called for equal
quarterly payments for a 10-year period with the right of
prepayment any time without penalty. Due to internal changes in
the firm, it is now proposed to refinance the loan through an
insurance company. The new loan is planned for a 20- year term
with an interest rate of 24% per annum, compounded quarterly.
The insurance company has a onetime service charge 5% of the
balance. This new loan also calls for equal quarterly payments.
a.) What is the balance due on the original mortgage (principal) if
all payments have been made through a full five years?
b.) What will be the difference between the equal quarterly
payments in the existing arrangement and the revised proposal?
Ans. (a) P 7,262,747.03; (b) P 120,862
Example 13: An annual payment is made for 10 years with an
annual interest rate of 8%. Compute the following:
(a) Uniform series present worth factor;
(b) Capital recovery factor;
(c) Uniform series compound amount factor;
(d) Sinking fund factor
Ans. (a) 6.710; (b) 0.149; (c) 14.487; (d) 0.069
Annuity Due
Annuity Due – a type of annuity were equal payments are made at
the beginning of each period.
𝐴 (1 + 𝑖)𝑛−1 − 1
𝑃=𝐴+ [ ]
𝑖 (1 + 𝑖)𝑛−1
𝐴 n = number of interest periods/number of equal payments
𝐹= [(1 + 𝑖)𝑛+1 − 1] − 𝐴
𝑖 m = number of interest periods when there is no payment made
Where:
P = value or sum of money at present
F = value or sum of money at some future time
A = series of periodic equal amount of payments
i = interest rate per interest period
n = number of interest periods/number of equal payments
SAMPLE PROBLEMS
Example 1: If money is worth 4% compounded semiannually,
find the present amount of an annuity due paying P 5,000
semiannually for a term of 3.5 years.
Ans. P 33,007.15
Example 2: A man agrees to make equal payments at the
beginning of each 6 months for 10 years to discharge a debt of P
50,000 due now. If money is worth 8% compounded
semiannually, find the semiannual payment.
Ans. P 3,537.58
Example 3: To accumulate a fund of P 80,000 at the end of 10
years, a man will make equal annual deposits in the fund at the
beginning of each year. How much should he deposit if the fund
is invested at 5% compounded annually?
Ans. P 6,057.49
Example 4: Determine the present worth and the accumulated
amount of an annuity consisting of 6 payments of P120, 000
each, the payment are made at the beginning of each year. Money
is worth 15% compounded annually.
Ans. P = P 522,259; F = P 1,208,016
Example 5: A farmer bought a tractor costing P 25,000 payable in
10 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.
Ans. P 4,077.20
Example 6: A certain manufacturing plant is being sold and was
submitted for bidding. Two bids were submitted by interested
buyers. The first bid offered to pay P 200,000 each year for 5
years, each payment being made at the beginning of each year.
The second bid offered to pay P 120,000 the first year, P 180,000
the second year, and P 270,000 each year for the next 3 years, all
payments being made at the beginning of each year. If money is
worth 12% compounded annually, which bid should the owner
of the plant accept?
Ans. second bid, Present worth = P 859,727.18
Deferred Annuity
Deferred Annuity – a type of annuity were the first payment is
made several periods after the beginning of annuity.
𝐴 (1 + 𝑖)𝑛 − 1
𝑃= [ ] (1 + 𝑖)−𝑚
𝑖 (1 + 𝑖)𝑛
Where:
P = value or sum of money at present
F = value or sum of money at some future time
A = series of periodic equal amount of payments
i = interest rate per interest period
SAMPLE PROBLEMS
Example 1: The present value of an annuity of R pesos payable
annually for 8 years, with the 1st payment at the end of 10 years
is P 187,481.25. Find the value of R if money if money is worth
5%.
Ans. P 45,000
Example 2: A parent on the day that child is born wishes to
determine what lump sum would have to be paid into an account
bearing interest of 5% compounded annually, in order to
withdraw P 20,000 each on the child’s 18th, 19th , 20th and 21th
birthdays?
Ans. P 30,941.73
Example 3: An asphalt road requires no upkeep until the end of 2
years when P60, 000 will be needed for repairs. After this P90,
000 will be needed for repairs at the end of each year for the next
5 years, then P120, 000 at the end of each year for the next 5
years. If money is worth 14% compounded annually, what was
the equivalent uniform annual cost for the 12-year period?
Ans. P 79,245.82
Example 4: A man wishes to provide a fund for his retirement
such that from his 60th to 70th birthdays he will be able to
withdraw equal sums of P18, 000 for his yearly expenses. He
invests equal amount for his 41st to 59th birthdays in a fund
earning 10% compounded annually. How much should each of
these amounts be?
Ans. P 2,285.25
Example 5: A lathe for a machine shop costs P 60,000, if paid in
cash. On the installment plan, a purchaser should pay P 20,000
downpayment and 10 quarterly installments, the first due at the
end of the first year after purchase. If money is worth 15%
compounded quarterly, determine the quarterly installment.
Ans. P 5,439.18
Example 6: A man invests P 10,000 now for the college education
of his 2 year old son. If the fund earns 14% effective interest rate,
how much will his son get each year starting from his 18 th to the
22nd birthday?
Ans. P 20,791.64
Perpetuity
Perpetuity – a type of annuity in which payments continue
indefinitely.
𝐴
𝑃=
𝑖
Where:
P = value or sum of money at present
A = series of periodic equal amount of payments
i = interest rate per interest period
SAMPLE PROBLEMS
Example 1: Find the present worth of perpetuity of P 5,200
payable monthly if the interest is 16% compounded monthly.
Ans. P 390,000
Example 2: Find the present value of a perpetuity of P 15,000
payable semiannually if money is worth 8% compounded
quarterly.
Ans. P 371,287
Example 3: If money is worth 8%, determine the present value of
a perpetuity of P 1,000 payable annually with the 1st payment
due at the end of 5 years.
Ans. P 9,187.87
Example 4: If money is worth 8% compounded quarterly,
calculate the present worth of the following:
(a) An annuity of P 1,000 payable quarterly for 50 years
(b) An annuity of P 1,000 payable quarterly for 100 years
(c) A perpetuity of P 1,000 payable quarterly
Ans. (a) P 49,047.35; (b) P 49,981.85; (c) P 50,000
Example 5: It costs P 50,000 at the end of each year to maintain a
section of Kennon road in Baguio City. If money is worth 10%,
how much would it pay to spend immediately to reduce the
annual cost by P 10,000?
Ans. P 400,000
Continuous Compounding for Discrete Payments
For an annuity compounded continuously, replace interest rate
with the effective rate for compounded continuously. Recall that:
𝐸𝑅 = 𝑒 𝑟 − 1
Replacing the interest rate for the formula of ordinary annuity
with ER, the formula becomes:
𝐴 𝑒 𝑟𝑛 − 1
𝑃= 𝑟 ( 𝑟𝑛 )
𝑒 −1 𝑒
𝐴
𝐹= (𝑒 𝑟𝑛 − 1)
𝑒𝑟 − 1
SAMPLE PROBLEMS
Example 1: Determine the accumulated amount to an account
paying P 5,000 annually (payments are made at the beginning of
each period) for 18 years if money is worth 8% compounded
continuously. Also determine the present worth.
Ans. P 209,452.57; P 49,625.13
Capitalized Cost
Capitalized Cost – is the sum of the first cost and the present
worth of all costs of replacement, operation and maintenance for
a long period of time of any property.
Capitalized Cost = First Cost + Present Worth of Perpetual
Operations and Maintenance + Present Worth of Perpetual
Replacement by Sinking Fund Method
𝑅
𝑃𝑟𝑒𝑠𝑒𝑛𝑡 𝑊𝑜𝑟𝑡ℎ 𝑜𝑓 𝑃𝑒𝑟𝑝𝑒𝑡𝑢𝑎𝑙 𝑅𝑒𝑝𝑙𝑎𝑐𝑒𝑚𝑒𝑛𝑡 =
(1 + 𝑖)𝐿 − 1
𝑅 = 𝐹𝐶 − 𝑆𝑉
Where:
R = replacement cost
FC = first cost
SV = salvage value
i = interest rate per interest period
L = useful life in years
SAMPLE PROBLEMS
Example 1: The first cost of a certain equipment is P 324,000 and
a salvage value of P 50,000 at the end of its life of 4 years. If
money is worth 6% compounded annually, find the capitalized
cost.
Ans. P 1,367,901.15
Example 2: Find the capitalized cost of a bridge whose cost is P
250M and life is 20 years. If the bridge must be partially rebuilt
at a cost of P 100M at the end of each 20 years. i = 6%.
Ans. P 295.3076M
Example 3: A machine cost P 150,000 and will have a scrap value
of P 10,000 when retired at the end of 15 years. If money is
worth 4%, find the annual investment and the capitalized cost of
the machine.
Ans. P 324,793.85
Example 4: A bridge that was constructed at a cost of P 7.5M is
expected to last 30 years at the end of which time its renewal
cost will be P 4M. Annual repairs and maintenance is P 300,000.
What is the capitalized cost of the bridge at an interest of 6%?
Ans. P 13,343,260.77
Example 5: Calculate the capitalized cost of a project that has an
initial cost of P 3,000,000 and an additional cost of P 1,000,000 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 P 300,000 every 13 yrs. Assume i =15%.
Ans. P 4,281,936
Uniform Arithmetic Gradient amortization as well as the equivalent uniform periodic payment.
Uniform Arithmetic Gradient – is the increase by a relatively (c) What is the equivalent uniform annual cost?
constant amount each period. Ans. P 15,178.34; P 18,449.37; P 4,280.47

A contract has been signed to lease a building at

P20,000 per year with an annual increase of P1,500
for 8 years. Payments are to be made at the end of
each year, starting one year from now. The prevailing
interest rate is 7%. What lump sum paid today would
be equivalent to the 8-year lease-payment plan?

The cash flow above is equal to the sum of the two cash flows
below:

A = P 1000, n = 5

We denote the difference between two preceding amount

(increase per period) as G, which is also known as uniform
gradient amount, in this case:
G = 500, n = 5
The formulas that may be used in this type of cash flow may be
analyzed using this formulas:
𝑃 = 𝑃𝐴 + 𝑃𝐺

𝐴 (1 + 𝑖)𝑛 − 1
𝑃𝐴 = [ ]
𝑖 (1 + 𝑖)𝑛

𝐺 (1 + 𝑖)𝑛 − 1
𝑃𝐺 = [ − 𝑛] (1 + 𝑖)−𝑛
𝑖 𝑖

𝑃𝐺 1 (1 + 𝑖)𝑛 − 1
= [ − 𝑛] (1 + 𝑖)−𝑛
𝐺 𝑖 𝑖

Where:
PG/G = Gradient to present worth factor

SAMPLE PROBLEMS
Example 1: An individual makes 5 deposits that increase
uniformly by P 300 every month in a savings account that earns
12% compounded monthly. If the initial deposit is P 4,500,
determine the accumulated amount in the account just after the
last deposit.
Ans. P 25,984.67
Example 2: An amortization of a debt is in a form of a gradient
series. (a) What is the equivalent present worth of the debt if
interest is 5%. (b) Determine also the future amount of
SET 2: DEPRECIATION
Depreciation – is the decrease in value of physical property with
the passage of time.
Book Value – is the worth of property as shown on the accounting
records of an enterprise
Salvage/Resale Value – is the price that can be obtained from the
sale of the property after it has been used.
Scrap Value – the amount of property would sell if disposed of as
junk.
𝐵𝑉𝑚 = 𝐹𝐶 − 𝐷𝑚
𝐷𝐿 = 𝐹𝐶 − 𝑆𝑉
Where:
BVm = book value of a property at any time m
Dm = total depreciation of a property at any time m
DL = total depreciation at the end of its useful life
FC = first cost
SV = salvage or scrap value
Straight Line Method
Straight Line Method –a method which assumes that the loss in
value is directly proportional to the age of the property.
𝑑1 = 𝑑2 = ⋯ = 𝑑𝑚 = 𝑑𝐿 = 𝑑
𝐹𝐶 − 𝑆𝑉
𝑑=
𝐿
𝐷𝑚 = 𝑚𝑑
𝐷𝐿 = 𝐿𝑑
Where:
d = depreciation at any year
Dm = total depreciation of a property at any time m
DL = total depreciation at the end of its useful life
L = useful life in years
FC = first cost
SV = salvage or scrap value
SAMPLE PROBLEMS
Example 1: A machine has an initial cost of P 50,000 and a
salvage value of P 10,000 after 10 years. Using Straight Line
Method of Depreciation:
(a) What is the annual depreciation?
(b) What is the book value after 5 years?
(c) What is the total depreciation after 3 years?
Ans. (a) P 4,000; (b) P 30,000; (c) P 12,000
Example 2: An Engineer bought an equipment for P 500,000. He
spent an additional amount of P 30,000 for installation and other
expenses. The salvage value is 10% of the first cost. If the book
value at the end of 5 years is P 291,500 using straight line
depreciation, compute the life of the equipment in years.
Ans. 10 years
Example 3: A machine which cost P 10,000 was sold as scrap
after being used for 10 years. The scrap value is P 500.
Determine the total depreciation at the end of 5 years.
Ans. P 4750
Example 4: An engineer bought an equipment for P 500,000.00.
He spent an additional amount of P 30,000 for installation and
other expenses. The salvage value is 10% of the initial first cost.
Life = 15 years. Compute the following:
(a) Annual Depreciation.
(b) Book Value after 6 years.
(c) Total depreciation after 10 years.
Ans. (a) P 31,800; (b) P 339,200; (c) P 318,000
Example 5: A machine cost P 73,500 and has a life of 8 years with
a salvage value of P 3500 at the end of 8 years. Determine the
book value at the end of 4 years using straight line method.
Ans. P 38,500
Example 6: What is the book value of electronic test equipment
after 8 years of use if it depreciates from its original value of P
120,000.00 to its salvage value of 13% in 12 years? Use straight-
line method.
Ans. P 50,400
Example 7: The initial cost of paint sand mill, including its
installation is, P800 000.00. The BIR approved life of this
machine is 10 years for depreciation. The estimated salvage
value of the mill is P 50,000.00 and the cost of dismantling is
estimated to be P 15,000.00. Using straight line depreciation,
what is the annual depreciation charge and what is the book
value of the machine at the end of six years?
Ans. P 76,500; P 341,000
Example 8: An equipment has a salvage value of P1M at the end
of 50 years. The straight line depreciation charge is P2M.
(a) What is the first cost of the machine?
(b) What is the book value after 25 years?
(c) At what year will its total depreciation be P30M?
Ans. P 101M; P 51M; 15th year
Sinking Fund Method
Sinking Fund Method – a method which assumes that the sinking
fund established in which funds will accumulate for replacement.
The total depreciation that has been taken place up to any given
time is assumed to be equal to the accumulated amount in the
sinking fund at any time.
𝑑1 = 𝑑2 = ⋯ = 𝑑𝑚 = 𝑑𝐿 = 𝑑
(𝐹𝐶 − 𝑆𝑉)𝑖
𝑑=
(1 + 𝑖)𝐿 − 1
𝑑
𝐷𝑚 = [(1 + 𝑖)𝑚 − 1]
𝑖
𝑑
𝐷𝐿 = [(1 + 𝑖)𝐿 − 1]
𝑖
Where:
d = depreciation at any year
Dm = total depreciation of a property at any time m
DL = total depreciation at the end of its useful life
L = useful life in years
FC = first cost
SV = salvage or scrap value
SAMPLE PROBLEMS
Example 1: Given FC = 100,000, SV = 10,000, L = 10 years, i = 5%.
(a) Annual Depreciation, d.
(b) Book Value after 3 years.
(c) Book Value after 8 years.
Ans. P 7,155.41; P 77,442.56; P 31,672.21
Example 2: An equipment cost P 100,000 with a salvage value of
P 5,000 at the end of 10 years.
Using Sinking Fund Method with interest rate= 4%.
(a) Compute the annual depreciation cost.
(b) Find the book values at years 1 to 4.
Ans. (a) P 7,912.64; (b) P 92,087.36; P 83,858.21; P 75,299.90; P
66,399.26
Example 3: A plant erected to manufacture socks with a first cost
of P 10,000,000 with an estimated salvage value of P 100,000 at
the end of 25 years. Find the appraised value to the nearest 100
by sinking fund method at 6% interest rate at the end of
a. 10 years By means of the Declining Balance Method, determine the yearly
b. 20 years depreciation charge for the first and second years.
Ans. P 7,621,600; P 3,362,200 Ans. P 12,969.60; P 9,965.84
Example 5: An engineer bought an equipment for P 800,000.
Other expenses, including installation, amounted to P 50,000. At
Example 4: A factory is constructed at a 1 st cost of P 8,000,000 the end of its estimated useful life of 10 years, the salvage value
and with an estimated salvage value of P 200,000 at the end of will be 10% of the first cost. Using the constant percentage
25 years. Find its appraised value to the nearest 100 at the end of method of depreciation, what is the book value after 5 years?
10 years by using sinking fund of depreciation assuming an Ans. P 268,793.20
interest of 5%.
Ans. P 5,944,400 Double Declining Balance Method
Example 5: A four-stroke motorbike costs P75 000.00. It will Double Declining Balance Method – a method which is similar to
have a salvage value of P10 000.00 when worn out at the end of declining balance method except that the rate of depreciation k is
eight years. Determine the annual replacement deposit using the replaced by 2/L.
SFM at 5%. 2 𝑚−1 2
Ans. P 6,806.92 𝑑𝑚 = 𝐹𝐶 (1 − )
𝐿 𝐿
Example 6: A machine that costs P75 000.00 five years ago now
cost P45 864.31, when 7% interest is applied using the sinking 2 𝑚
𝐵𝑉𝑚 = 𝐹𝐶 (1 − )
fund formula. Determine the salvage value of the machine for an 𝐿
estimated useful life of 10 years.
𝐷𝑚 = 𝐹𝐶 − 𝐵𝑉𝑚
Ans. P 5,000
Where:
Declining Balance Method (Matheson’s Method) dm = depreciation at any time m
Declining Balance Method – a method which assumes that the BVm = book value of a property at any time m
annual cost of depreciation is a fixed percentage (k) of the Dm = total depreciation of a property at any time m
salvage value at the beginning of the year. L = useful life in years
𝑑𝑚 = 𝐹𝐶(1 − 𝑘)𝑚−1 𝑘 FC = first cost
𝐵𝑉𝑚 = 𝐹𝐶(1 − 𝑘)𝑚
SAMPLE PROBLEMS
𝑆𝑉 = 𝐹𝐶(1 − 𝑘)𝐿 Example 1: A machine has a first cost of P 140,000 and a life of 8
years with a salvage value of P 10,000 at the end of its useful life.
𝐿 𝑆𝑉
Using double declining balance method:
𝑘 =1− √ (a) What is the Book Value on the 3rd year?
𝐹𝐶
(b) What is the depreciation charge on the 4th year?
Ans. P 59,062.50; P 14,765.63
𝐷𝑚 = 𝐹𝐶 − 𝐵𝑉𝑚
Example 2: An equipment costs P 500,000 and has a salvage
Note: This method is not applicable if there is no salvage value. value of P 25,000 after its 25 years of useful life. Using Double
Where: Declining Balance Method, what will be the book value after 8
dm = depreciation at any time m years?
BVm = book value of a property at any time m Ans. P 256,609.44
Dm = total depreciation of a property at any time m Example 3: XYZ Company has an equipment that cost P 90,000.
L = useful life in years After 8 years, it will have a salvage value of P 18,000.00. Using
FC = first cost Double declining balance method, find the book value at the end
SV = salvage or scrap value of 5 years.
k = rate of depreciation Ans. P 21,357
Example 4: Given the following data for a construction
SAMPLE PROBLEMS equipment: Initial cost = P 1,200,000.00; Economic Life = 12
Example 1: A machine costing P 720,000 is estimated to have a years; Estimated salvage value = P 320,000.00.
book value of P 40,545.73 when retired at the end of 10 years. (a) What is the book value after seven years?
Depreciation cost is computed using a constant percentage of the (b) What is the depreciation charge on the 4 th year?
declining value. (c) What is the total depreciation charge at the end of the 10 th
(a) What is the annual rate of depreciation? year?
(b) What is the book value after 3 years? Ans. P 334,898; P 115,740.74; P 1,006,193.30
(c) What is the depreciation charge at the 4th year? Example 5: A machine costing P 550,000 has an estimated scrap
(d) What is the total depreciation after 6 years? value of P 85,000 at the end of its economic life of 8 years. Using
Ans. (a) 0.25; (b) P 303,750; (c) P 75,937.50; (d) P 591,855.47 DDBM of depreciation:
Example 2: A machine having a certain 1st cost has a life of 10 (a) What is the book value after 4 years of service?
years and a salvage value of 6.633% of the first cost of 10 years. (b) What is the book value at the end of its life?
If it has a book value of P 58,914 after 6 years, how much is the Ans. P 174,023; P 55,062.10
first cost of the machine using Matheson’s Method?
Ans. P 300,049.23 Sum of the Years Digit Method
Example 3: A machine has a current price of P 400,000. If its (𝐹𝐶 − 𝑆𝑉)
𝑑𝑚 = (𝑟𝑒𝑣𝑒𝑟𝑠𝑒 𝑑𝑖𝑔𝑖𝑡)
selling price is expected to decline at the rate of 10% per annum, 𝑠𝑢𝑚 𝑜𝑓 𝑡ℎ𝑒 𝑑𝑖𝑔𝑖𝑡𝑠
what will be the selling price after 5 years?
(𝐹𝐶 − 𝑆𝑉)
Ans. P 236,196.00 𝐷𝑚 = (𝑠𝑢𝑚 𝑜𝑓 𝑟𝑒𝑣𝑒𝑟𝑠𝑒 𝑑𝑖𝑔𝑖𝑡𝑠)
𝑠𝑢𝑚 𝑜𝑓 𝑡ℎ𝑒 𝑑𝑖𝑔𝑖𝑡𝑠
Example 4: A radio service panel truck initially costs P 56,000. I
resale value at the end of the fifth year is estimated at P 15,000.
 𝐿 Example 1: A television company purchased machinery for P
𝑠𝑢𝑚 𝑜𝑓 𝑡ℎ𝑒 𝑑𝑖𝑔𝑖𝑡𝑠 = (𝐿 + 1)
2 100,000 on July 1, 1979. It is estimated that it will have a useful
𝑟𝑒𝑣𝑒𝑟𝑠𝑒 𝑑𝑖𝑔𝑖𝑡 = 𝐿 − 𝑚 + 1
𝑚 for 14,000 hours in 1979 and 18,000 hours is 1980. The
𝑠𝑢𝑚 𝑜𝑓 𝑟𝑒𝑣𝑒𝑟𝑠𝑒 𝑑𝑖𝑔𝑖𝑡𝑠 = (2𝐿 − 𝑚 + 1)
2 machinery produces 36,000 units in 1979 and 44,000 units in
Where:
dm = depreciation at any time m
Dm = total depreciation of a property at any time m
L = useful life in years
FC = first cost
SV = salvage or scrap value
SAMPLE PROBLEMS
Example 1: An asset is purchased for P 9000. Its estimated life is
10 years, after which is will be sold for P 1,000. Using SOYD
(a) Find the book value during the 3rd year.
(b) Find the depreciation during the 2nd year.
(c) Find the total depreciation after 4 years.
Ans. P 5,072.72; P 1,309.09; P 4,945.45
Example 2: Mr. Q purchased a Bulk Milk Cooler for P 480,000.00.
Shipping, tax, and installation costs amounted to P 25,000.00, P
20,000.00 and P 15,000.00. The machine has a useful life of 7
years and salvage value of P 40,000.
(a) Determine the book value after four years.
(b) Determine the depreciation charge on its last year of service.
(c) Determine the total depreciation after 3 years.
Ans. P 147,142.86; P 17,857.14; P 321,428.57
Example 3: A telephone company purchased microwave radio
equipment for P 6 million, freight and installation charges
amounted to 4% of the purchased price. If the equipment will be
depreciated over a period of 10 years with a salvage value of 8%,
determine the depreciation cost during 5th year using SYD.
Ans. P 626,269.10
Example 4: A company purchases an asset for P 10,000.00 and
plans to keep it for 20 years. If the salvage value is zero at the
end of the 20th year:
(a) What is the depreciation in the third year?
(b) What is the total depreciation at the end of 14 years?
(c) What is the book value of the asset at the end of 8 years?
Use sum-of-the-year’s digits depreciation.
Ans. P 857.14; P 9,000; P 3,714.29
Example 5: An equipment costing P 500,000.00 has a life
expectancy of 5 years. Using some-of-the-year’s digit method of
depreciation, what must be its salvage value such that its
depreciation charge for the first year is P 100,000.00?
Ans. P 200,000.00
Service-Output Method
Service-Output Method – a method which assumes that the total
depreciation that has taken place is directly proportional to the
quantity of output of the property up to that time.
(𝐹𝐶 − 𝑆𝑉)
𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡 𝑜𝑢𝑡𝑝𝑢𝑡 =
𝑇 (b) Sinking Fund Method with interest at 8%;
(𝐹𝐶 − 𝑆𝑉)
𝐷𝑚 = (𝑄)
𝑇
Where:
Dm = total depreciation of a property at any time
FC = first cost
SV = salvage or scrap value
T = total units of output up to the end of its life
Q = total number of units of output at any time
SAMPLE PROBLEMS
of 10 years, scrap value of P 4,000, production of 400,000 units
and working hours of 120,000. The company uses the machinery
1980. Compute the depreciation charge for 1980 using each
method given below:
(a) Straight Line Method
(b) Working Hours Method
(c) Output method
Also compute the total depreciation at the end of 1980 using:
(d) Working Hours Method
(e) Service Output Method
Ans. P 9,600; P 14,400; P 10,560; P 25,600; P 19,200
Example 2: An asphalt and aggregate mixing plant having a
capacity of 50 cu.m. every hour costs P 2,500,000. It is estimated
to process 800,000 cu.m. during its life. During a certain year it
processed 60,000 cu.m. If its scrap value is P 100,000, determine
the total depreciation during the year and the depreciation cost
chargeable to each batch of 50 cu.m. using the service output
method.
Ans. P 180,000.00; P 150.00
SUPPLEMENTARY PROBLEMS
Example 1: A machine costs P 7,000 which last for 8 years with a
salvage value at the end of its life of P 350. Determine the
depreciation charge during the 4th year and the book value at the
end of 4 years by:
(a) Straight Line Method;
(b) Declining Balance Method;
(c) SOYD Method;
(d) Sinking Fund Method with interest of 12%;
(e) Double Declining Balance Method
Ans. (a) P 831.25, P 3,675; (b) P 710.96, P 1,565.25; (c) P 923.61,
P 2,197.22; (d) P 540.66, P 4,416.00; (e) P 738.28; P 2,214.84
Example 2: A P 110,000 chemical plant had an estimated life of 6
years and a projected scrap value of P 10,000. After 3 years of
operation, an explosion made it a total loss. How much money
would have to be raised to put up a new plant costing P 150,000,
if the depreciation reserve was maintained during its 3 years of
operation by:
(a) Straight Line Method;
(b) Sinking Fund Method at 6% interest
Ans. P 100,000; P 104,359.08
Example 3: A contractor imported a bulldozer for his job, paying
P 250,000 to the manufacturer. Freight and insurance charges
amounted to P 18,000; customs’, broker’s fees and arresters
services amounted to P 8,500; taxes, permits, and other expenses
which is 10% of the purchasing cost. If the contractor estimates
the life of the bulldozer to be 10 years with a salvage value of P
20,000, determine the book value at the end of 6 years using the:
(a) Straight Line Method;
(c) Matheson’s Formula;
(d) SOYD Method
Ans. P 132,600; P 158,949.69; P 59,201.53; P 71,181.82
Example 4: An equipment costs P 10,000 with a salvage value of
P 500 at the end of 10 years. Calculate the annual depreciation
cost by:
(a) Straight Line Method;
(b) Sinking Fund Method at 4% interest
Ans. P 950; P 791.26
Example 5: A radio service panel truck initially costs P 56,000. Its
resale value at the end of the 5th year is estimated at P 15,000.
(a) Determine the annual depreciation charge by SLM.
(b) By means of the Matheson’s Formula, determine the yearly
depreciation charge for the first, second and third year.
Ans. P 8,200; P 12,969.60, P 9,965.84, P 7,657.75
SET 3: BASIC METHODS FOR ECONOMY STUDIES
Rate of Return Method (ROR)
Rate of Return – is a measure of the effectiveness of an
investment of capital and its financial efficiency. When this
method is used, it is necessary to decide whether the computed
rate of return is sufficient to justify the investment.
𝑛𝑒𝑡 𝑎𝑛𝑛𝑢𝑎𝑙 𝑝𝑟𝑜𝑓𝑖𝑡
𝑅𝑂𝑅 =
𝑐𝑎𝑝𝑖𝑡𝑎𝑙 𝑖𝑛𝑣𝑒𝑠𝑡𝑒𝑑
𝑛𝑒𝑡 𝑎𝑛𝑛𝑢𝑎𝑙 𝑝𝑟𝑜𝑓𝑖𝑡 = 𝑎𝑛𝑛𝑢𝑎𝑙 𝑟𝑒𝑣𝑒𝑛𝑢𝑒 − 𝑎𝑛𝑛𝑢𝑎𝑙 𝑐𝑜𝑠𝑡
Annual cost includes depreciation, labor and material cost,
overhead, rental, tax and insurances, etc.
SAMPLE PROBLEMS
Example 1: An investment of P 270,000 can be made in a project
that will produce a uniform annual revenue of P 185,400 for 5
years and having a salvage value of 10% of the investment. Out of
pocket costs for operation and maintenance will be P 81,000 per
year. Taxes and insurance will be 4% of the first cost per year.
The company expects capital to earn not less than 25% before
income taxes. Using ROR method, determine the rate of return of
the investment. Is this a desirable investment?
Ans. ROR = 23.70%; It is not a desirable investment
Example 2: A young mechanical engineer is considering
establishing his own small company. An investment of P 800,000
will be required which will be recovered in 15 years. It is
estimated that sales will be P 800,000 per year and that
operating expenses will be as follows.
Materials P 160,000 per year
Labor P 280,000 per year
Overhead P 40,000 +10% of sales per year
Selling expense P 60,000
The man will give up his regular job paying P 216,000 per year
and devote full time to the operation of the business; this will
result in decreasing labor cost by P40,000 per year, material cost
by P 28,000 per year and overhead cost by P32,000 per year. If
the man expects to earn at least 20% of his capital, should he
invest? Compute for the actual rate of return.
Ans. The man should not invest; ROR = 6.6118%
Example 3: The ABC Company is considering constructing a plant
to manufacture a proposed new product. The land costs P
15,000,000, the building costs P 30,000,000, the equipment costs
P 12,500,000, and P 5,000,000 working capital is required. At the
end of 12 years, the land can be sold for P 25,000,000, the
building for P 12,000,000, the equipment for P 250,000 and all of
the working capital recovered. The annual disbursements for
labor, materials, and all other expenses are estimated to cost P
23,750,000. If the company requires a minimum return of 25%,
what should be the minimum annual sales for 12 years to justify
the investment?
Ans. P 39,748,563.43
Example 4: A man formerly employed as chief mechanic of an
automobile repair shop has saved P 1,000,000.00 which are now
invested in certain securities giving him an annual dividend of
15%. He now plans to invest this amount in his own repair shop.
In his resent job, he is earning P 25,000.00 a month, but he has to
resign to run his own business. He will need the services of the
following: 2 mechanics each earning P400.00 a day, and 8
helpers each earning P200.00 a day. These men will work on the
average 300 days per year. His other expenses are the following:
Rental P30,000.00 a month
Miscellaneous P25,000.00 a month
Sales tax 3% of gross income
Insurance 2%
The length of his lease is 5 years. If the average charge for each
car repaired by his shop is P 1,000.00. Determine the number of
cars he must service in one year so that he will obtain a profit of
at least 20% on his investment?
Ans. 2112 cars
Annual Worth Method
Annual Worth Method – in this method, interest on the original
investment (sometimes called minimum required profit) is
included as cost. If the excess of annual cash inflows over annual
cash outflows is not less than zero, the proposed investment is
justified.
𝐴𝑛𝑛𝑢𝑎𝑙 𝑐𝑎𝑠ℎ 𝑖𝑛𝑓𝑙𝑜𝑤 − 𝐴𝑛𝑛𝑢𝑎𝑙 𝑐𝑎𝑠ℎ 𝑜𝑢𝑡𝑓𝑙𝑜𝑤 ≥ 0
SAMPLE PROBLEMS
Example 1: An investment of P 270,000 can be made in a project
that will produce a uniform annual revenue of P 185,400 for 5
years and having a salvage value of 10% of the investment. Out of
pocket costs for operation and maintenance will be P 81,000 per
year. Taxes and insurance will be 4% of the first cost per year.
The company expects capital to earn not less than 25% before
income taxes. Using annual worth method, determine the annual
cash flow. Is this a desirable investment?
Ans. –P 3,509; It is not a desirable investment
Example 2: A man is considering investing P 500,000 to open a
semi-automatic auto washing business in a city of 400,000
population. The equipment can wash, on the average, 12 cars per
hour, using two men to operate it and to do small amount of
hand work. The man plans to hire two men, in addition to
himself, and operate the station on an 8-hour basis, 6 days per
week, and 50 weeks per year. He will pay his employees P 25.00
per hour. He expects to charge P 25.00 for a car wash. Out-of-
pocket miscellaneous cost would be P 8,500 per month. He
would pay his employees for 2 weeks vacation each year.
Because of the length of his lease, he must write off his
investment within 5 years. His capital now is earning 15%, and
he is employed at a steady job that pays P 25,000 per month. He
desires a rate of return of at least 20% of his investment. Using
annual worth method, determine the excess of annual revenue
over the annual cost. Would you recommend the investment?
Ans. P 19,040; the man should invest
Present Worth Method
Present Worth Method – this method is based on the concept of
present worth. If the present worth of all net cash flows is equal
to or greater than zero, the project is justified. Cash inflow
includes annual revenue and salvage or scrap value. Depreciation
is excluded in cash outflow.
𝑃𝑟𝑒𝑠𝑒𝑛𝑡 𝑊𝑜𝑟𝑡ℎ 𝑜𝑓 𝑎𝑙𝑙 𝑛𝑒𝑡 𝑐𝑎𝑠ℎ 𝑓𝑙𝑜𝑤𝑠 ≥ 0
SAMPLE PROBLEMS
Example 1: An investment of P 270,000 can be made in a project
that will produce a uniform annual revenue of P 185,400 for 5
years and having a salvage value of 10% of the investment. Out of
pocket costs for operation and maintenance will be P 81,000 per
year. Taxes and insurance will be 4% of the first cost per year.
The company expects capital to earn not less than 25% before
income taxes. Using present worth method, determine the
present worth of all net cash flows. Is this a desirable
investment?
Ans. –P 9,436.00; It is not a desirable investment
Future Worth Method
Future Worth Method – this method is exactly comparable to the
present worth method except that all cash inflows and outflows
are compounded forward to a reference point in time called the
future.
𝐹𝑢𝑡𝑢𝑟𝑒 𝑊𝑜𝑟𝑡ℎ 𝑜𝑓 𝑎𝑙𝑙 𝑛𝑒𝑡 𝑐𝑎𝑠ℎ 𝑓𝑙𝑜𝑤𝑠 ≥ 0
SAMPLE PROBLEMS
Example 1: An investment of P 270,000 can be made in a project
that will produce a uniform annual revenue of P 185,400 for 5
years and having a salvage value of 10% of the investment. Out of
pocket costs for operation and maintenance will be P 81,000 per
year. Taxes and insurance will be 4% of the first cost per year.
The company expects capital to earn not less than 25% before
income taxes. Using future worth method, determine the future
worth of all net cash flows. Is this a desirable investment?
Ans. –P 28,796.50; It is not a desirable investment

Payback (Payout) Period Method

Payback Period – is defined as the length of time required to
recover the first cost of an investment from the net cash flow
produced by the investment for an interest rate of zero.
Depreciation is not included in cash outflow.
𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 − 𝑆𝑎𝑙𝑣𝑎𝑔𝑒 𝑉𝑎𝑙𝑢𝑒
𝑃𝑎𝑦𝑏𝑎𝑐𝑘 𝑃𝑒𝑟𝑖𝑜𝑑 =
𝑁𝑒𝑡 𝑎𝑛𝑛𝑢𝑎𝑙 𝑐𝑎𝑠ℎ 𝑓𝑙𝑜𝑤

SAMPLE PROBLEMS
Example 1: An investment of P 270,000 can be made in a project
that will produce a uniform annual revenue of P 185,400 for 5
years and having a salvage value of 10% of the investment. Out of
pocket costs for operation and maintenance will be P 81,000 per
year. Taxes and insurance will be 4% of the first cost per year.
The company expects capital to earn not less than 25% before
income taxes. Determine the payback period.
Ans. 2.6 years
Example 2: A fixed capital investment of P 10,000,000.00 is
required for a proposed manufacturing plant and an estimated
working capital of P 2,000,000.00. Annual depreciation is
estimated to be 10% of the fixed capital investment. Determine
the rate of return on the total investment and the payout period
is the annual profit is P 2,500,000.00.
Ans. ROR = 12.5%; 4.8 years
SET 4: COMPARING ALTERNATIVES
Rate of Return on Additional Investment Method
The formula for the ROR on additional investment is:
𝑎𝑛𝑛𝑢𝑎𝑙 𝑛𝑒𝑡 𝑠𝑎𝑣𝑖𝑛𝑔𝑠
𝑅𝑂𝑅 𝑜𝑛 𝑎𝑑𝑑𝑖𝑡𝑖𝑜𝑛𝑎𝑙 𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 =
𝑎𝑑𝑑𝑖𝑡𝑖𝑜𝑛𝑎𝑙 𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡
𝑎𝑛𝑛𝑢𝑎𝑙 𝑛𝑒𝑡 𝑠𝑎𝑣𝑖𝑛𝑔𝑠 = 𝑑𝑖𝑓𝑓𝑒𝑟𝑒𝑛𝑐𝑒 𝑖𝑛 𝑎𝑛𝑛𝑢𝑎𝑙 𝑐𝑜𝑠𝑡
𝑎𝑑𝑑𝑖𝑡𝑖𝑜𝑛𝑎𝑙 𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 = 𝑑𝑖𝑓𝑓𝑒𝑟𝑒𝑛𝑐𝑒 𝑖𝑛 𝑐𝑎𝑝𝑖𝑡𝑎𝑙 𝑖𝑛𝑣𝑒𝑠𝑡𝑒𝑑
If the minimum required rate of return is 15%. What is the EUAC
of Type A? Type B? Which equipment should be selected?
Ans. P 129,850; P 126,060; Type B
Present Worth Cost Method
In comparing alternatives by this method, determine the present
worth of the net cash outflows for each alternative for the same
period of time. The alternative with the least present worth of
cost is selected.

SAMPLE PROBLEMS
If the rate of return on additional investment is satisfactory, then, Example 1: Example 1: A company is considering two types of
the alternative requiring a bigger investment is more economical equipment for its manufacturing plant. Pertinent data are as
and should be chosen. follows:
Type A Type B
SAMPLE PROBLEMS First cost P 200,000 P 300,000
Example 1: A company is considering two types of equipment for Annual operating cost P 32,000 P 24,000
its manufacturing plant. Pertinent data are as follows: Annual labor cost P 50,000 P 32,000
Type A Type B Insurance and property taxes 3% 3%
First cost P 200,000 P 300,000 Payroll taxes 4% 4%
Annual operating cost P 32,000 P 24,000 Estimated Life 10 10
Annual labor cost P 50,000 P 32,000 If the minimum required rate of return is 15%. What is the
Insurance and property taxes 3% 3% present worth of Type A? Type B? Which equipment should be
Payroll taxes 4% 4% selected?
Estimated Life 10 10 Ans. P 651,689; P 632,643; Type B
If the minimum required rate of return is 15%, which equipment
should be selected? What is the rate of return of return on
additional investment?
Ans. Type B; 18.79%

Annual Cost Method

To apply this method, the annual cost of alternatives including
interest on investment is determined. The alternative with the
least annual cost is chosen.

SAMPLE PROBLEMS
Example 1: Example 1: A company is considering two types of
equipment for its manufacturing plant. Pertinent data are as
follows:
Type A Type B
First cost P 200,000 P 300,000
Annual operating cost P 32,000 P 24,000
Annual labor cost P 50,000 P 32,000
Insurance and property taxes 3% 3%
Payroll taxes 4% 4%
Estimated Life 10 10
If the minimum required rate of return is 15%. What is the
annual cost of Type A? Type B? Which equipment should be
selected?
Ans. P 129,850; P 126,056; Type B

Equivalent Uniform Annual Cost Method

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

SAMPLE PROBLEMS
Example 1: Example 1: A company is considering two types of
equipment for its manufacturing plant. Pertinent data are as
follows:
Type A Type B
First cost P 200,000 P 300,000
Annual operating cost P 32,000 P 24,000
Annual labor cost P 50,000 P 32,000
Insurance and property taxes 3% 3%
Payroll taxes 4% 4%
Estimated Life 10 10
Break-Even Analysis

SAMPLE PROBLEMS
Example 1: The cost of producing a small transistor radio set
consists of P 23.00 for labor and P 37.00 for materials. The fixed
charges in operating the plant are P 100,000 per month. The
variable cost is P 1.00 per set. The radio set can be sold for P
75.00 each. Determine how many sets must be produced per
month to break-even.
Ans. 7,143 sets
Example 2: A company has a production capacity of 500 units per
month and its fixed costs are P 250,000 a month. The variable
costs per unit are P 1,150 and each unit can be sold for P 2,000.
Economy measures are instituted to reduce the fixed costs by
10% and the variable cost be 20%. (a) Determine the old break-
even point.
(b) Determine the new break-even point.
(c) What is the old monthly profit at 100% capacity?
(d) What is the new monthly profit at 100% capacity?
Ans. 294 units per month; 208 units per month; P 175,000; P
315, 000
Example 3: Two machines are being considered for the
production of a particular part for which there is a long term
demand. Machine A costs P 50,000 and is expected to last 3 years
and have a P 10,000 salvage value. Machine B costs P 75,000 and
is expected to last 6 years and have zero salvage value. Machine
A can produce a part in 18 seconds; Machine B requires only 12
seconds per part. The out-of-pocket hourly cost of operation is P
38 for A and P 30 for B. Monthly maintenance costs are P 200 for
A and P 220 for B. If interest on invested capital is 25%,
determine the number of parts per year at which the machines
are equally economical.
Ans. 29, 544 parts
Benefit-Cost Ratio
SAMPLE PROBLEMS
Example 1: A non-profit educational research organization, is
contemplating an investment of P 1,500,000 in grants to develop
new ways to teach people the rudiments of profession. The
grants would extend over a ten-year period and would achieve
an estimated savings of P 500,000 per year in professors’
salaries, student tuition, and other expenses. The program would
be an addition to ongoing and planned activities, thus an
estimated P 100,000 a year would have to be released from the
other program to support the educational research. A rate of
return of 15% is expected, calculate the B/C ratio. Is this a good
program?
Ans. B/C = 1.34; It is a good program
Example 2: The National Government intends to build a dam and
hydroelectric project in the Cagayan Valley at a total cost of P
455,500,000. The project will be financed by soft foreign load
with a rate of interest of 5% per year. The annual cost for
operation and maintenance, distribution facilities and others
would total P 15,100,000. Annual revenues and benefits are
estimated to be P 56,500,000. If the structures are expected to
last for 50 years, with no salvage value, determine the B/C ratio
of the project.
Ans. B/C = 1.41