SEA CE 4161 Engineering Economics MODULES

COURSE GUIDE IN
CE 4161
ENGINEERING ECONOMICS
SCHOOL OF ENGINEERING AND ARCHITECTURE
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MODULE 1
THE FOUNDATIONS OF ENGINEERING ECONOMY
Unit 1
INTRODUCTION TO ENGINEERING ECONOMY
UNIT LEARNING OUTCOMES
 TLO 1.1: To solve Cost Concept applications of cost concepts present economy studies
Write your answers in the space provided

Kylie’s Student Loan
Kylie has been offered a student loan by a hometown engineering firm. She will borrow
P5O,000 each year for 4 years. She is required to maintain an average grade of 85, major
in any of the engineering program, and graduate within 5 years. Beginning 1 year after
graduation and continuing for 3 more years, she is required to repay this loan at P50,000
per year. Is this a good deal? Why?
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Property of and for the exclusive use of SLU. Reproduction, storing in a retrieval system, distributing, uploading or posting online, or transmitting in any form or by any
means, electronic, mechanical, photocopying, recording, or otherwise of any part of this document, without the prior written permission of SLU, is strictly prohibited. 2
Introduction
The Accreditation Board for Engineering and Technology states that engineering “is the
profession in which knowledge of the mathematical and natural sciences gained by study, experience, and
practice is applied with judgement to develop ways to utilize, economically, the materials and forces of
nature for the benefit of mankind.” In this definition, the economic aspects of engineering are emphasized,
as well as the physical aspects. Clearly, it is essential that the economic part of engineering practice be
accomplished well. Thus, engineers use knowledge to find ways of doing things economically.
(Eshenbach,2011)
Definition of 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 (Sta. Maria, 2000)
 Engineering Economy adjust for the time value of money to balance current and future
revenue and costs. (Eschenbach, 2011)
 Beginning with the Module 2, interest will be defined and used, but for now, we need to
recognize that having 100 pesos today has more value than having 100 pesos in a year. If you
doubt that money has time value, why are you not eager to loan someone P1,000 now to be
repaid P1,000 at the end of the year?
Principles of Engineering Economy
 The foundation of engineering economy is defined to be a set of principles that provide a

comprehensive doctrine for developing the methodology.
 Once a problem or need has been clearly defined, the foundation of the discipline can be
discussed in terms of seven principles.
Principle 1: Develop the alternatives

Carefully define the problem! Then the choices is among alternatives. The alternative
Principle 2 Focus
need to be on the
identified anddifferences
then defined f analysis.
Principle 2: Focus on the differences

Only the differences in expected future outcomes, among the alternatives relevant to
their comparison and should be considered in the decision.
Principle 3: Use a consistent Viewpoint

The prospective outcomes of the alternatives, economic and others, should be
Principle 2 Focus
consistently on the from
developed differences
a defined view point.
Principle 4 Use a common unit of measure

Using a common unit of measurement to enumerate as many of the prospective
outcomes as possible will simplify the analysis of the alternatives.
Principle 5 Consider all relevant criteria

Selection of a preferred alternative requires the use of a criterion or several criteria.
The decision process should consider both the outcomes enumerated in the monetary
unit and other unit of measurement or made explicit in a descriptive manner.
Principle 6 Make Risk and Uncertainty Explicit

Risk and uncertainty are inherent in estimating the future outcomes of the alternatives
and should be recognized in their analysis and comparison.
Principle 7 Revisit your Decisions

The initial projected outcomes of the selected alternative should be subsequently
compared with actual results achieved.
Engineering Economy and the Design Process
 An engineering economy study is accomplished by using a structured procedure and

mathematical modelling techniques.
 The economic results are then used in a decision situation that normally includes other
engineering knowledge and input.
Decision-making Flowchart
Illustrative example of applying the 7 steps of the decision making process (Eschenbach, 2011)
Charlene Selects a Pump
Charlene is a newly hired chemical engineer. She has been asked to select a
pump to move 15,000 liters of slurry a day to the pollution treatment center.
What process should she use to select the pump?
Solution:
1. Define Problem: Key problem characteristics include but not limited to

(1) slurry characteristics, such as particle and corrosiveness; (2) pipe size
and flow velocities for input and output; (3) any size, power, and location
restrictions; (4) time horizon for using the pump and how soon is it
needed; (5) cost limits; (6) vendor selection process-purchase order,
competitive bid and (7) how many pumps are needed.
2. Choose Objectives: Costs over the pump’s life and technical performance
will usually dominate, but Charlene must also consider other factors, such
as vendor and pump reliability, similarity to current practice,
maintainability, and flexibility for change.
3. Identify Alternatives: If the pump will be purchased from a catalog or

other vendor material, then Charlene must assemble and examine those
materials from all appropriate vendors.
4. Evaluate Consequences: Charlene must enumerate each alternative’s

advantages and disadvantages with respect to the objectives.
5. Select: Charlene must select a pump based on costs and benefits

adjusted for the time value of money. Technical performance objectives
must be completely satisfied, so that any pump with deficiencies is
eliminated from consideration.
6. Implement. The pump must be ordered and installed.
7. Audit. This step evaluate the pump and the decision-making process after
the pump is in use. The intent is to provide “lessons learned” to assist
future decision.
 It is also useful to focus on how to do each step correctly
1. Define Problem: The key skill in problem definition is asking questions and correctly
pulling together information from a variety of sources.
2. Choose Objective(s): the most common error is considering only the costs to purchase or
build. The correct objective considers the time value of money and all costs and benefits.
These include purchase, installation, overhaul, operation, and disposal costs, and the
benefits that occur over the projects life.
3. Identify Alternatives: The best alternative may be overlooked if the problem is defined
too narrowly. Or the problem might be defined properly, but creativity is missing. As
many alternatives as possible should be suggested. One way of generating ideas and
enhancing creativity is through brainstorming, in which a group generates as many ideas
as possible.
4. Evaluate Consequence: A common mistake when evaluating alternatives is short

sighted focus on which consequence to include. At first, consequences may be evaluated
in a cursory way, because this may be enough to eliminate obviously inferior alternatives.
The consequences for the better alternatives maybe evaluated in more detail.
5. Select: Selecting the best alternative and choosing the correct objective is are closely
linked. The selection criteria should be based on identified objective.
6. Implement: The selection process may determine the success or failure of

implementation. The key here is the involvement of stakeholders (the people affected by
thee process: employees, customer, users, managers, owners, and stockholders).
7. Audit: This step is often omitted. The pressure to move on and complete the next
project is substantial. An audit trail can be helpful later. Record the source of each data
item. Remember that the reward for auditing is learning.
Ethics and Decision Making
 Business and personal decision making is guided by ethics.
 This includes establishing systems of belief and moral obligations, defining values and
fairness, and determining duty and guidelines for conduct.
 Ethics are so important that professional engineering societies, organizations, and every
individual possess ethical codes or standards of conduct.
 Example: the Code of Ethics of the National Society of Professional Engineers has as its
fundamental canon:
Engineers, in the fulfilment of their professional duties, shall:

 Hold Paramount the health, safety, and welfare of the public.
 Perform services only in areas of their competence.
 Issue public statements only in an objective and truthful manner.
 Act for each employer or client as faithful agents or trustees
 Avoid deceptive acts.
 Conduct themselves honorably, responsibly, ethically, and lawfully so as to enhance the

honor, reputation, and usefulness of the profession.
 There are ethical issues that can arise at every step of the decision making process described
in the table below.
Self Assessment 1: Application of the Engineering Economic Analysis Procedure.

Try answering the following questions.
Your friend is considering investing in a two-year MBA program. Tuition costs will
be $60,000 for two years while living expenses will be $25,000 per year. She has
$10,000 in savings, which she can spend on her education, and will need to borrow
the rest from her bank. Her annual loan repayment will be $10,500. She currently
works
means, electronic, mechanical, as anrecording,
photocopying, analyst and makes
or otherwise of any part$60,000 a year;
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hopes to work as a manager for $150,000 a year.
Refer to the seven-step procedure to answer these questions:
Unit 2
COST CONCEPTS AND DESIGN ECONOMICS
TLO 1.2: To solve Cost Concept applications of cost concepts present economy studies
“The correct solution to any problem depends primarily on a true understanding of what the problem
really is”
- Arthur M. Wellington (1887)
Diagnostic Quiz on Cost Classification: Classify each of the following cost items as
mostly fixed or variable cost. Write F for fixed cost and V for variable cost on the space provided on the
left of the cost being classified. Answer the following problems
____ Raw Material ______ Administrative Salaries
____ Direct Labor ______ Payroll Taxes
____ Depreciation ______ Insurance of building
____Supplies ______ Clerical salaries
____ Utilities ______ Sales commission
___ Property Tax ______ Rent
COSTS TERMINOLOGY (by Obaidullah Jan, ACA, CFA and last modified on Mar 26, 2019)
Costs are classified into fixed costs, variable costs or mixed costs (based on behavior); product costs or period
costs (for external reporting); direct costs or indirect costs (based on traceability); and sunk costs, opportunity
costs or incremental costs (for decision-making).
Classification of costs based on behavior helps in cost-volume-profit analysis. Classification based

on traceability is important for accurate costing of jobs and units produced. Classification for the purpose of
decision-making is important to help management identify costs which are relevant for a decision.
Cost Classification Diagram

The following diagram summarizes the different categories into which costs are classified for different
purposes:
PRODUCT COSTS VS PERIOD COSTS
Product costs (also called inventoriable costs) are costs assigned to the manufacture of
products and recognized for financial reporting when sold. They include direct materials,
direct labor, factory wages, factory depreciation, etc.
Period costs are on the other hand are all costs other than product costs. They include
marketing costs and administrative costs, etc.
 Breakup of Product Costs
The product costs are further classified into direct materials, direct labor and manufacturing
overhead costs:
Direct materials: Represents the cost of the materials that can be identified directly
with the product at reasonable cost. For example, cost of paper in newspaper printing,
etc.
 Direct labor: Represents the cost of the labor time spent on that product, for example
cost of the time spent by a petroleum engineer on an oil rig, etc.
 Manufacturing overhead costs: Represents all production costs except those for
direct labor and direct materials, for example the cost of an accountant's time in an
organization, depreciation on equipment, electricity, fuel, etc.
DIRECT COSTS VS INDIRECT COSTS
The product costs that can be specifically identified with each unit of a product are called
direct product costs. Whereas those which cannot be traced to a specific unit are indirect
product costs. Thus direct material cost and direct labor cost are direct product costs whereas
manufacturing overhead cost is indirect product cost.
PRIME COSTS VS CONVERSION COSTS
Prime costs are the sum of all direct costs such as direct materials, direct labor and any other
direct costs.
Conversion costs are all costs incurred to convert the raw materials to finished products and
they equal the sum of direct labor, other direct costs (other than materials) and manufacturing
overheads.
FIXED COSTS VS VARIABLE COSTS
Fixed costs are costs which remain constant within a certain level of output or sales. This
certain limit where fixed costs remain constant regardless of the level of activity is called
relevant range. For example, depreciation on fixed assets, etc.
Variable costs are costs which change with a change in the level of activity. Examples
include direct materials, direct labor, etc.
Mixed costs (also called semi-variable costs) are costs which have both a fixed and a variable
component.
SUNK COSTS VS OPPORTUNITY COSTS
Sunk costs are those costs that have been irreversibly incurred or committed; they may also
be termed unrecoverable costs.
Opportunity costs which are costs of a potential benefit foregone. For example the
opportunity cost of going on a picnic is the money that you would have earned in that time.
GENERAL ECONOMIC ENVIRONMENT
 There are numerous general economic concepts that must be taken into account in engineering
studies.
 In broad terms, economics deals with the interactions between people and wealth, and engineering is
concerned with the cost-effective use of scientific knowledge to benefit humankind.
This section introduces some of these basic economic concepts and indicates how they may be factors for
consideration in engineering studies and managerial decisions.
CONSUMER AND PRODUCER GOODS AND SERVICES

The goods and services that are produced and utilized may be divided conveniently into two classes.
Consumer goods and services are those products or services that are directly used by people to
satisfy their wants. Food, clothing, homes, cars, television sets, haircuts, opera, and medical services
are examples.
The providers of consumer goods and services must be aware of, and are subject to, the changing
wants of the people to whom their products are sold.
Producer goods and services are used to produce consumer goods and services or other producer
goods. Machine tools, factory buildings, buses, and farm machinery are examples.
NECESSITIES vs LUXURIES
Goods and services may be divided into two types: necessities and luxuries. Obviously, these terms
are relative because for most goods and services, what one considers a necessity may be considered a
luxury by another.
For example: a person living in one community may find a car is a necessity to get to and from work.
If the same person lived and worked in a different city with adequate public transportation, a car
would be a luxury.
PRICE and DEMAND
There is a relationship between the price that must be paid and the quantity that will be
demanded or purchased. This general relationship is depicted in the figure below.
As the selling price per unit (p) is increased, there will be less demand (D) for the product,
and as the selling price is decreased, the demand will increase.
COMPETITION
Because economic laws are general statements regarding the interaction of people and wealth, they
are affected by the economic environment in which people and wealth exists.
Perfect competition occurs in a situation in which any given product is supplied by a large
number of vendors and there is no restriction on additional suppliers entering the market.
Under such conditions, there is assurance of complete freedom from both buyer and seller.
Monopoly is the opposite of perfect competition. A perfect monopoly exists when a unique
product or service is only available from a single supplier and that vendor can prevent the
entry of all others into the market. Under such conditions, the buyer is at the complete mercy
of the supplier in terms of availability and price of the product.
ACCOUNTING FUNDAMENTALS
Accounting is often referred to as the language of business. Engineers should make serious effort to
learn about a firm’s accounting practice so that they can better communicate with top management.
The following diagram shows relationship of business with various parties
Accounting is a system for measuring, processing, and communicating financial information. It is often
referred to as the language of business.
A key product of an accounting information system, financial statements allow people to make informed
business decision.
THE ACCOUNTING EQUATION

-is the most basic tool of accounting
-this equation presents the resources of the business and claims to those sources.
Assets = Liabilities + Owner’s Equity

Economic = Claims to Economic Resources
Resources
Assets – (economic resources) examples are cash, land, building, furniture
Liabilities – (outsider claims) financial obligations to outsiders called the

creditors.
Owner’s Equity – (insiders claim) claims held by the owners of the business.
This means that if the business has no liabilities then all the assets belongs to the owner because
assets = owner’s equity.
ACCOUNTING FOR BUSINESS TRANSACTION
Transaction- is any event that affect the financial positions of the business entity.
- a transaction always has a value received and value parted with
- Value – property, cash, service, or a right.
Ex1: Mr Lee bought land for the business
Value received- land
Value parted with – cash
Ex2: Mr. Lee paid the salary of helper.

Value received – services
Value parted with- cash
Ex3: Mr Lee sold goods on account.

Value received – right to collect from customer
Value parted with is goods
Transactions affect a business’s assets, liabilities, and owner’s equity.

Therefore every transaction affects the accounting equation.
The following example shows a new accounting equation every time a transaction occurs.
Transaction 1 (T1): Mr. Lee invested cash of P100,000 and land worth P300,000 in the business.
Assets = Liabilities +
Owner’s Equity
Cash P100,000 Mr. LEE Capital – P400,000
Land 300,000
Transaction 2 (T2): Mr. Lee borrowed P100,000 from the bank.
Assets =
Liabilities + Owner’s Equity
Cash – 200,000 Accounts Mr. LEE Capital – P400,000
Land – 300,000 Payable to Bank
- P100,000
Showing the effect of T1 and T2 in the accounting equation using the table:
Transaction Asset Liabilities Owner’s Equity
Cash Land
T1 100,000 300,000 400,000
T2 100,000 100,000
Expanded Accounting Equation
Assets = Liabilities + (Beginning Owner’s Equity + revenue –expenses)
T3: Mr. Lee received P20,000 cash for services rendered to customer

Cash – 220,000 Accounts Mr. LEE Capital –P400,000
Land – 300,000 Payable to Bank Service Income – 20,000
P100,00
T4 –Mr. Lee paid P5,000 the salary of his helper.

Cash – 215,000 Accounts Mr. LEE Capital –P400,000
Land – 300,000 Payable to Bank Service Income – 20,000
P100,00 Salary Expense – 5,000
The table below shows the effect of the different transactions shown above that is summarized using the table
with the corresponding account titles as headings and the amount with proper sign as entries.
Transaction Asset Liabilities Owner’s Equity

Cash Land Owner’s Income or Expense
Equity Revenue
T1 +100,000 +300,000 +400,000
T2 +100,000 +100,000
T3 +20,000 +20,000
T4 -5,000 -5,000
THE BALANCE SHEET

- Shows the financial condition of the business.
- It follows the format of the accounting equation.
- The balance sheet is affected whenever there is a transaction.
MR Lee
BALANCE SHEET
Assets Liabilities and Capital

Cash P 215,000 Accounts Payable to Bank P100,000
Land 300,000 Mr. LEE Capital 400,000
________ Add: Profit 15,000 415,000
Total Assets P 515,000 Total Liabilities and Capital P515,000
INCOME STATEMENT
-It is an itemized statement summarizing the changes in proprietorship resulting from the business
operations between dates.
-It follows the format of the profit equation.
Profit = Income/ Revenue - Expenses
-The purpose is to provide the owner/s with information regarding the progress of the business at
regular intervals (month, quarter, semester, or year).
-Most companies use the year as the accounting period.
Mr. Lee
Income Statement
Income P20,000
Less: Salary Expense 5,000
Net Income/Profit P15,000
=====
TYPES OF BUSINESS ORGANIZATIONS

- A business takes one of three forms of organization:
Difference between Balance sheet of Sole Proprietorship, Partnership and Corporation
For sole and partnership, the balance sheet presentation is the same except for multiple capital for
partnership.
example
A and B Partnership
Balance Sheet
Assets Liabilities and Partner’s Equity
Cash Accounts Payable

Accounts Receivable A, Capital
Equipment B, Capital
For corporation, the balance sheet is different in the owner’s equity because the capitalization of a
corporation is in the form of capital stock
example
Mlab Corporation
Balance Sheet
Assets Liabilities and Stockholder’s Equity
Cash Accounts Payable

Account Receivable Common Stock
Equipment Retained Earnings
Difference between the Income Statement for Service type, Merchandising, and Manufacturing Firm
For Service type:

Mr X Laundry Service
Income Statement
For the month of December
Income from service P 100,000

Less: Operating Expenses 60,000
Net Profit P 40,000
======
For Merchandising Business (engaged in buying and selling):
Mr X Dry Goods
Income Statement
Sales P100,000
Less Cost of Goods Sold 60,000
Gross Profit from Sales 40,000
Less: Operating expense
Selling 5,000
Administrative 5,000 10,000
P 30,000
=====
For Manufacturing Firm:
Llan Manufacturing Company

Income Statement
For the Year Ended December 31, 2000
Sales P1,000,000
Less Cost of good Manufactured and Sold 400,000
Gross Profit 600,000
Less: Selling Expenses 200,000
Net Income from Sales 400,000
Less: Administrative Expenses 100,000
Net Income for the year P 300,000
=====
Cost of Goods Manufactured
Raw Materials Used P150,000
Direct Labor 150,000
Factory Overhead 100,000
Total P400,000
======
PRESENT ECONOMY
 When alternatives for accomplishing a specific task are being compared over one year of less
and the influence of time on money can be ignored.
 The rules, or criteria, shown below will be used to select the preferred alternatives when
defect-free output is variable or constant among the alternatives being considered.
Rule 1 : When revenues/income and other economic benefit are present and vary among
alternatives, choose the alternative that maximizes overall profitability based on the
number of defect-free units of a product or serviced produced.
Rule 2 : When revenues/income and other economic benefit are not present or are
constant among all alternatives, consider only the costs and select the alternative that
minimizes total costs per defect-free unit of product or service output.
Illustrative Example on how to make present economy studies:
Choosing the Most Economic Material for a Part

Sample Problem: A good example of this situation is illustrated by a part for which annual demand is 100,000
units. The part is produced on a high-speed turret lathe, using 1112 screw-machine steel costing $0.30 per
pound. A study was conducted to determine whether it might be cheaper to use brass screw stock, costing
$1.40 per pound. Because the weight of steel required per piece was 0.0353 pounds and that of brass was
0.0384 pounds, the material cost per piece was $0.0106 for steel and $0.0538 for brass. However, when the
manufacturing engineering department was consulted, it was found that, although 57.1 defect-free parts per
hour were being produced by using steel, the output would be 102.9 defect-free parts per hour if brass were
used. Which material should be used for this part?
Solution
The machine attendant is paid $15.00 per hour, and the variable (i.e., traceable) overhead costs for the turret
lathe are estimated to be $10.00 per hour. Thus, the total cost comparison for the two materials is as follows:
1112 Steel Brass

Material $0.30 x 0.0353 = $0.0106 $1.40 x 0.0384 = $0.0538
Labor $15.00/57.1 = 0.2627 $15.00/102.9 = 0.1458
Variable $10.00/57.1 = 0.1751 $10.00/102.9 = 0.0972
overhead
Total cost $0.4484 $0.2968
per piece
Saving per piece by use of brass = $0.4484 — $0.2968 = 0.1516
Because
100,000
parts are
made each
year,
Choosing the Most Economical Machine for Production
Sample Problem: Two currently owned machines are being considered for the production of a part. The
capital investment associated with the machines is about the same and can be ignored for purposes of this
example. The important differences between the machines are their production capacities (production rate x
available production hours) and their reject rates (percentage of parts produced that cannot be sold). Consider
the following table:
Machine A Machine B
Production rate 100 parts/hour 130 parts/hour
Hours available for production 7 hours/day 6 hours/day
Percent parts rejected 3% 10%
The material cost is $6.00 per part, and all defect-free parts produced can be sold for $12 each. (Rejected
parts have negligible scrap value.) For either machine, the operator cost is $15.00 per hour and the variable
overhead rate for traceable costs is $5.00 per hour.
(a) Assume that the daily demand for this part is large enough that all defect-free parts can be sold. Which
machine should be selected?
(b) What would the percent of parts rejected have to be for Machine B to be as profitable as Machine A?
Solution
(a) Rule 1 applies in this situation because total daily revenues (selling price per part times the number of
parts sold per day) and total daily costs will vary depending on the machine chosen. Therefore, we should
select the machine that will maximize the profit per day:
Profit per day = Revenue per day — Cost per day

= (Production rate)(Production hours)($12/part) x [1 — (%rejected/100)] — (Production rate) (Production
hours) ($6/part)
— (Production hours) ($15/hour + $5/hour).
Machine A: Profit per day = (100 parts/hour) (7 hours/ day ) ($12/part) (1-10.03) — (100 parts/hour) (7
hours/day) ($6/part)
— (7 hours/day) ($15/hour + $5/hour) = $3,808 per day.
Machine B: Profit per day = (130 parts/hour) (6 hours/day) ( $12/part) (1-10.10) — (130 parts/hour) (6
hours/day) ($6/part) — (6 hours/day) ($15/hour + $5/hour) = $3,624 per day.
Therefore, select Machine A to maximize profit per day. Answer
(b) To find the breakeven percent of parts rejected, X, for Machine B, set the profit per day of Machine A
equal to the profit per day of Machine B, and solve for X:
$3,808/day = (130 parts/hour) (6 hours/day) ($12/part) (1—X) — (130 parts/hour) x (6 hour/day) ($6/part )
— (6 hours/day) ($15/hour + $5/hour)
Thus, X = 0.08, so the percent of parts rejected for Machine B can be no higher than 8% for it to
be as profitable as Machine A. Answer
Self
Assessmen
t M1.2.
Try your
skill by
answering
the
following
problems.
1. Record
the effect
of the
following
transaction
s on the
accounting
equation
using a
table
similar to
the
example.
a.
Owe
n
inhe
rite
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$20
Module 1- Unit 2 Evaluative Assessment
Problem Solving: Please answer the following problems in a short bond paper with heading (Module
1 Evaluate M1.2)
1. a) State the expanded accounting equation.

b) Explain the meaning of each term in the equation
2. On January 1, Orange Crates had assets of P30,000 and owner’s equity of P20,000.
During the year, the company had cash revenue or income of P10,000, cash expenses of
P8,000, paid 3,000 to its creditors, and its owner withdrew P1,000. What are the assets,
liabilities, and owner’s equity at the end of the year?
3. Determine the value received and value parted with for the following transactions:
Value Received Value Parted With
a) Paid rent.
b) Rendered professional services for cash.
c) Withdrew P100 for personal service.
d) Paid the balance of P350 on a typewriter
previously purchased on account.
e) Purchased office supplies.
4. Raymond opened the Muscles Fitness Gym in August. The Following transactions occurred
during the first month of the business:
a) Raymond invested P100,000 in cash and 30,000 in gym equipment in the business.
b) Paid P10,000 for the first month’s rent.
c) Purchased supplies costing P4,000 on credit.
d) Purchased exercise equipment costing P25,000 for 15,000 cash and the rest on
account.
e) Recorded income for the first half of the month of P6,500 in cash and P3,500 on
account.
f) Paid P2,750 to a creditor on account.
g) Received payment from a customer on account for P1600.
h) Raymond withdrew P500 for a graduation gift.
i) Paid aerobics instructor her salary, P3,000.
j) Paid miscellaneous expense P1,500
k) Recorded income for the second half of the month of P5,600 in cash.
Prepare
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storing every
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distributing, uploading or occurs.
posting online, or transmitting in any form or by any
5. In the design of an automobile engine part, an engineer has a choice of either
steel casting or an aluminum alloy casting. Either machine provides the same
service. However, the steel casting weighs 8 ounces, compared with 5 ounces
for the aluminum casting. Every pound of extra weight in the automobile has
been assigned a penalty of $6 to account for increased fuel consumption during
the life cycle of the car. The steel casting costs $3.20 per pound, while the
aluminum allow can be cast for $7.40 per pound. Machining cost per casting are
$5.00 for steel and $4.20 for aluminum. Which material should the engineer
select, and what is the difference in unit costs? 1 pound = 16 ounce
References
Main Reference:
Sullivan, W. G, Wicks, E.M. and Koelling C.P (2014). Engineering Economy. Pearson Education,
LImited.
Eshenbach, Ted G. (2011). Engineering Economy: Applying Theory to Practice. New York. Oxford
University Press
Sta Maria, Hipolito (2000). Engineering Economy. National Bookstore.
Blank, Leland and Tarquin Anthony (2018). Engineering Economy

, McGraw-Hill
End of Module 1
MODULE 2
MONEY-TIME RELATIONSHIPS AND EQUIVALENCE
Unit 1
Simple Interest and Compound Interest
 TLO 2.1: Solve varied applications involving singular cash flows and multiple cash flows
through proper use of interest and time concepts
Diagnostic Test : Please try answering the questions below.

What is interest for you?
Where did you experience interest?
Interest= is the amount of money paid for the use of borrowed capital or the income produced
by money which has been loaned.
1. Simple Interest
Simple interest is calculated using the principal only, ignoring any interest that had been accrued in
preceding periods. In practice, simple interest is paid on short – term loans in which the time of the loan is
measured in days.
I = Pni
F = P + I = P + Pni
F = P (1 + ni)
Where: I = interest paid or received ( pesos or dollars)

P = principal or present worth ( pesos or dollars)
n = number of interest periods ( years or semiannual, quarters, months days)
i = rate of interest per interest period (in %/period, in most cases %/yr)
F = accumulated amount or future worth ( pesos and dollars)
Example 1: What will be the future worth of money after 14 months, if a sum of ₱10,000 is invested at a
simple interest rate of 12% per year?
Given: P = ₱10,000
n = 14 months x ( 1 yr/12 months ) = 1.16667 years
i = 12%/year
Required: F =?
Solution:
14
F = P(1+ni) = ₱10,000 [1 + ( x 0.12)] = ₱11,400
12
(a) Ordinary simple interest is computed on the basis of 12 months of 30 days each or 360 days a
year.
1 year = 360 days and 1 month = 30days
Example 2: Determine the ordinary simple interest on ₱700 for 8 months and 15 days if the rate of interest is
15%.
Given: P = ₱700
i = 15%/year
n = 8 months and 15 days
Required: I = interest = ?
Solution: Number of days = (8) (30) + 15 = 255 days
255
I = Pni = ₱700 x x 0.15 = ₱74.38 answer
360
(b) Exact simple interest is based on the exact number of days in a year, 365 days for an ordinary
year and 366 days for a leap year.
1 year = 365 days 1year= 366 days for leap year
Example 3: Determine the exact simple interest on ₱500 for the period from January 10 to October 28, 1996
at 16% interest.
Given: P = ₱500
i = 16% /year
n = January 10 to October 28, 1996
Required: I = interest = ?
Solution: 1st step: solve for the value of n by identifying if year 1996 is a leap year or not
A year is considered a leap year if the year is divisible by 4, since 1996/4 = 499 therefore 1996 is
a leap year.
Jan. 10 – 31 = 21 (excluding Jan.10)
February = 29 (leap year means February has 29 days instead of 28 days
March = 31
April = 30
May = 31
June = 30
July = 31
August = 31
September = 30
October = 28 (including Oct. 28)
292 days
292
Exact simple interest = ₱500 x x 0.16 = ₱63.83 answer
366
2. Cash – Flow Diagrams
A cash – flow diagram is simply a graphical representation of cash flows drawn on a time scale. Cash
– flow diagram for economic analysis problems is analogous to that of free body diagram for mechanics
problems
means, electronic, mechanical, photocopying,receipt (positive
recording, or otherwisecash
of anyflow
part ofor
thiscash without the prior written permission of SLU, is strictly prohibited. 28
inflow)
document,
Note: The time scale is represented by a horizontal line. The scale made could be in years, semi-annual,
quarters, months, or days depending on the problem.
Example 4: A loan of ₱100 at simple interest of 10% will become ₱150 after 5 years.
Solution:
Cash flow diagram on the viewpoint of the lender
₱150
0 1 2 3 4 5
₱100
Cash flow diagram on the viewpoint of the borrower
₱100
0 1 2 3 4 5
₱150
3. Compound Interest
In calculation of compound interest, the interest for an interest period is calculated on the principal
plus total amount of interest accumulated in previous periods. Thus compound interest means “interest on top
of interest.”
P
0 1 2 3 4 n-1 n
F
Example: if P= P100,000 n=3 years i =10%

Pattern of interest compounding
Interest Principal at Interest Earned During Amount at End of year
Period Beginning of year year
Year I = ( P @ beg) x 10%
n
1 100,000 Pi = 10,000 P + Pi = 110,000
2 110,000 110,000 (10%) = 11,000 110,000+ 11,000=121,000
3 121,000 121,000(10%) = 12,100 121,000+12,100= 133,100
Therefore ,
Compound Interest (Borrower’s Viewpoint)
Interest Principal at Beginning Interest Earned During Period Amount at End of Period
Period of Period =I F
n
1 P Pi P + Pi = P(1+i)
2 P (1+i) P(1+i) i P(1+ni) + P(1+i) I = P (1+i)2
3 P (1+i)2 P (1+i)2 i P (1+i)2 + P (1+i)2 i = P (1+i)3
… … … …
n P (1+i)n - 1 P (1+i)n – 1 i P (1+i)n
F = P (1+i)n
The quantity (1+i)n is commonly called the “single payment
compound amount factor” and is designated by the functional
symbol F/P, i%, n. Thus,
F = P (F/P, i%, n)
The symbol F/P, i%, nPis=read as “F
F (1+i) -n given P at i per cent in n
interest periods”.
The quantity (1+i)-n is commonly called the “single payment
present worth factor” and is designated by the functional symbol
P/F, i%, n. Thus,
P = F (P/F, i%, n)
The symbol P/F, i%, n is read as “P given F at i per cent in n
interest periods”.
4. Rates of Interest
(a) Nominal rate of interest
The nominal rate of interest specifies the rate of interest and a number of interest periods in
one year.
r
i=
m
Where: i = rate of interest per interest period
r = nominal interest rate
m = number of compounding periods per year
example: 12% compounded annually r=12% m=1 i = 12%/1 = 12%/year

12% compounded semi-annually r=!2% m=2 i = 12%/2 = 6%/SA
12% compounded quarterly r= 12% m= 4 i = 12%/4 = 3%/quarter
12% compounded monthly r= 12% m=12 i = 12%/12 = 1%/month
(b) Effective rate of interest or Effective Interest Rate (EIR)

Effective rate of interest is the actual or exact rate of interest of a nominal rate on the
principal during one year
Effective interest rate EIR = (1 + r/m)m - 1 = (1 + i)m -1
. If ₱1.00 is invested at a nominal rate of 15% compounded quarterly, after one year this will become,
0.15 4
₱1 (1 + ) = ₱1.1586
4
The actual interest earned is ₱0.1586, therefore, the rate of interest after one year is 15.86%.
Hence,
Where: F1 = the amount ₱1.00 will be after one year
F1 = 1.1586
0 or otherwise
means, electronic, mechanical, photocopying, recording, 1 of2any part of this document, without the priormwritten permission of SLU, is strictly prohibited. 31
₱1.00
Example 5: Find the nominal rate which if converted quarterly could be used instead of 12% compounded
monthly. What is the corresponding effective rate?
Solution:
Let r = the unknown nominal rate
For the two or more nominal rates to be equivalent, their corresponding effective rates must be equal.
Nominal rate Effective rate
r% compounded quarterly r 4
(1 + ) –1
4
12% compounded monthly 0.12 12

(1 + ) –1
12
r 4
(1 + ) – 1 = 1 ( 1+ 0.01)12 – 1
4
r
1+ = ( 1.01)3 = 1.0303
4
r = 0.1212 or 12.12% compounded quarterly
Equation of Value
An equation of value is obtained by setting the sum of the sum of the values on a certain comparison or focal
date of one set of obligations equal to the sum of the values on the same date of another set of obligation.
Steps: 1. Read problem.
2. make cashflow diagram
3. set focal date
4. make the equation (value of money should be computed depending on the focal
date that was set)
∑ values of one set of obligation = ∑ values of another set of obligations

Or
∑ values represented by arrows going up = ∑ values represented by arrows going down
Example 6: Find the amount at the end of two years and seven months if ₱1,000 is invested at 8%
compounded quarterly using simple interest for anytime less than a year interest period.
Solution: Construct cash flow diagram (note that original cash flow is represented by color black cash flow)
8% F2
For compound interest: i = = 2%, n = (2)(4) = 8
4 F1
7
For simple interest: i = 8%, n =
12
0 1 2 2yrs & 7mns
compound simple
interest interest
₱1,000
Solve for F1 first
F1 = P (1+i)n = ₱1,000 (1+ 0.02)8 = ₱1,171.66
Then solve for F2
7
F2 = F1 (1+ni) = ₱1,171.66 [1+ (0.08)]= ₱1, 226.34
12
Or using equation of values
F2
0 1 2 2yrs & 7mns

compound simple
interest interest
₱1,000
Using “ 2 “ as focal point

( this means that end of year 2 is time present, therefore, cash flow P1,000 is 2 years in the past
while F2 is 7 months in the future. We solve for the future worth of P1000 and present worth of F 2)
Equation:
1,000 (1.02) 8 = F2 { 1/ (1+(7/12)(.08)}
1171,66 = F2 {0.9954}
F2 = 1226.34
Example 7: A man bought a lot worth ₱1,000,000 if paid in cash. On the installment basis, he paid a down
payment of ₱200,000; ₱300,000 at the end of one year; ₱400,000 at the end of three years and a final
payment at the end of five years. What was the final payment if interest was 20% per year?
Solution:
Let Q= the final payment ₱800,000
0 1 2 3 4 5
₱300,000
₱300,000 (P/F, 20%,1) ₱400,000
₱400,000 (P/F, 20%,3) Q
Q (P/F, 20%,5)
Using “0” as focal date
₱800,000 = ₱300,000 (P/F, 20%,1) + ₱400,000 (P/F, 20%,3) + Q (P/F, 20%,5)

₱800,000 = ₱300,000 (1.20)-1 + ₱400,000 (1.20)-3 + Q (1.20)-5
₱800,000 = ₱300,000 (0.8333) + ₱400,000 (0.5787) + Q (0.4019)
Q = ₱792, 560
Using “3” as focal point
₱800,000
800,000 (F/P, 20%,3)
0 1 2 3 4 5
₱300,000
₱300,000 (F/P, 20%,2) ₱400,000
Q (P/F, 20%,2)
₱800,000(F/P,20%,3) = ₱300,000 (F/P, 20%,2) + ₱400,000 + Q (P/F, 20%,2)

₱800,000(1.20)3 = ₱300,000 (1.20)2 + ₱400,000 + Q (1.20)-2
₱800,000 ( 1.728) = ₱300,000 (1.44) + ₱400,000 + Q (0.6944)
Q = ₱792, 560
Solve following exercises (hand written in a short bond paper) . Show complete solution.
Work on the following exercise. This is an opportunity for you to practice your knowledge and skills you
acquired in this unit. Final answers are provided at the end of each problem to serve as your guide.
1. A loan of ₱2,000 is made for a period of 13 months, from January 1 to January 31 the following year,
at a simple interest rate of 20%. What future amount is due at the end of the loan period? Ans:
₱2,433.33
3. Determine the exact simple interest on ₱5,000 for the period from Jan. 15 to Nov. 28, 1992, if the rate
of interest is 22%. Ans: ₱955.74
4. A man wishes his son to receive ₱200,000 ten years from now. What amount should he invest if it
will earn interest of 10% compounded annually during the first 5 years and 12% compounded
quarterly during the next 5 years? Ans: ₱68,758.67
5. At a certain interest rate compounded semiannually, ₱5,000 will amount to ₱20,000 after 10 years.
What is the amount at the end of 15 years? Ans: ₱40,029.72
6. Jones Corporation borrowed ₱9,000 from Brown Corporation on Jan. 1, 1978 and ₱12,000 on Jan. 1,
1980. Jones Corporation made a partial payment of ₱7,000 on Jan. 1, 1981. It was agreed that the
balance of the loan would be amortized by two payments, one of Jan. 1, 1982 and the other on Jan. 1,
1983, the second being 50% larger than the first. If the interest rate is 12%, what is the amount of
each payment? Ans: ₱9,136.91; ₱13,705.36
End of Unit 1
MODULE 2
The Time Value of Money
Unit 2
Ordinary Annuity and Deferred Annuity
 TLO 2.2: To solve problems that involve time value of money calculations and to illustrate
economic equivalence involving uniform cash flows
Crisis in the Gulf
One of the biggest man-made environmental catastrophe in American History-

millions of gallons of oil flowing unchecked into the Gulf of Mexico from an undersea
well. In response to this tragedy, British Petroleum (BP) will make payments into a
fund to pay for some of the damages to the Gulf Coast resulting from their massive
oil spill in April and following months of 2010. BP will pay $3 billion at the end of the
third quarter of 2010 and another $2 billion in the fourth quarter of 2010. BP will
then make payments of $1.25 billion each quarter thereafter until a total of $ 20
billion has been paid into the fund. If the opportunity cost of capital (interest rate)
is 3% per quarter, what is the equivalent value of this payment stream at the
beginning of the third quarter of 2010? This is one type of problem you can answer
after studying unit 2 of module 2.
An annuity is a series of equal payments occurring at equal periods of time.

Symbols and Their Meaning:
P = value or sum of money at present
F = value or sum of money at some future time
A = a series of periodic, equal amounts of money
n = number of interest period
i = interest rate per interest period F= occurs at the same time as last A
P = occurs one period before first A
0 1 2 3 4 n-1 n
A A A A A A
1. Ordinary Annuity
An ordinary annuity is one where the payments are made at the end of each period.
(a) Finding P when A is Given
P = occurs one period before first A
0 1 2 3 4 n-1 n
A A A A A A
To derive the formula of P/A, we apply equation of values, using “0” as focal point.
∑ P = ∑ each A’s at 0
P = A(1+i)-1 + A(1+i)-2 + A(1+i)-3 + A(1+i)-4 ….+ A(1+i)-(n-1) + A(1+i)-n
*since this equation is a geometric sequence, therefore the formula for P/A is…
P = A (P/A, i%, n)
[ ]
−n
1−( 1+i )
P=A
i
The quantity in brackets is called the “uniform series present worth factor.”
(b) Finding F when A is Given
F= occurs at the same times as last A
0 1 2 3 4 n-1 n
A A A A A A
To derive the formula of F/A, we apply equation of values, but this time using “n” as focal point.
∑ F = ∑ each A’s at n
F = A(1+i)(n-1) + A(1+i)(n-2) + A(1+i)(n-3) + A(1+i)(n-4) ….+ A(1+i)n-n
*since this equation has a geometric sequence, therefore the formula for F/A is…
F = A (F/A, i%, n)
F=A
[ ( 1+i )n−1
i ]
The quantity in brackets is called the “uniform series compound amount factor.”
(c) Finding A when P is Given
A = P (A/P, i%, n)
A=P
[ i
1−( 1+i )
−n
]
The quantity in brackets is called the “capital recovery factor.”
(d) Finding A when F is Given
A = F (A/F, i%, n)
A=F
[ i
( 1+i )n−1 ]
The quantity in brackets is called the “sinking fund factor.”
The above discussions are further clarified by the following examples. Examining the solution to each
example can give you deeper insights into the subject matter.
Example 1: What are the present worth and the accumulated amount of a 10-year annuity paying ₱10,000 at
the end of each year, with interest at 15% compounded annually?
Given: A = ₱10,000/year n = 10 yrs i = 15%/year
Required: P and F
F
0 1 2 3 9 10
₱10,000 ₱10,000 ₱10,000 ₱10,000 ₱10,000
₱10,000 (P/A, 15%, 10)
For P: ₱10,000 (F/A, 15%, 10)
P = A (P/A, i%, n) = ₱10,000 (P/A, 15%, 10)
[ ]
−10
1−( 1.15 )
P = ₱10,000 = ₱50,188 answer
0.15
For F:
F = A (F/A, i%, n) = ₱10,000 (F/A, 15%, 10)
F = ₱10,000
[ ( 1.15 )10−1
0.15 ]
= ₱203,037 answer
Example 2: What is the present worth of ₱500 deposited at the end of every three months for 6 years if the
interest rate is 12% compounded semiannually?
Given: A= ₱500/ quarter n= 6 yrs x 4Q/yr = 24 quarters r=12%CSA
Solution:
1st For i/Q : For solving for the interest rate per quarter, need to convert 12%CSA to r%CQ and then
get i%/Q
(1+i)4 – 1 = 1+ ( 0.12
2 ) -1
2
i + 1 = ( 1.06 ) 0.5
i = 0.0296 or 2.96% per quarter
2nd For P:
P = A (P/A, 2.96%, 24)
[ ]
−24
1−( 1+ 0.0296 )
= ₱500
0.0296
= ₱500 (17.0087)
P = ₱8,504 ans.
Example 3: Mr. Reyes borrows ₱600,000 at 12% compounded annually and agreeing to pay the loan in 15
annual payments. How much of the principal is still unpaid after he has made the 8 th payment?
Given: P= ₱600,000 n= 15 years r=12%CA
Required: x= principal still unpaid after 8th payment
Solution: i = r/m= 12%/1 = 12%/year
First solve for A
A = 600,000
[ 0.12
1−( 1+ 0.12 )
−15
] = ₱ 88,094.54
Then solve for x:
x = 88,094.52
[
1−( 1.12 )−7
0.12 ]
x= ₱402,041.94
Example 3: M purchased a small lot in a subdivision, paying ₱200,000 down and promising to pay ₱15,000
every 3 months for the next 10 years. The seller figured interest at 12% compounded quarterly. a) What was
the cash price of the lot? b) If M missed the first 12 payments, what must he pay at the time the 13 th is due to
bring himself up to date?
Solution: i = r/m = 12%/ 4 = 3%/Q
P =Cash price
0 1 2 3 39 40 Q
A= ₱15,000/Q
₱200,000
a) Using “0” as focal point ∑ =∑
P = ₱200,000 + ₱15,000/Q
[ 1−( 1.03 )−40
.03 ]
P = ₱ 546,721.58
b) Let x= amount to be paid at the time the 13th is due to bring M up to date.
0 1 2 3 12 13 Q
A= ₱15,000/Q
Using “13” as focal pt
X = ₱15,000/Q
[ ( 1.03 )13−1
.03 ] = ₱ 234,266.86
Example 4: A man approaches the ABC Loan Agency for ₱100,000 to be paid in 24 monthly instalments.
The agency advertises an interest rate of 1.5% per month. They proceed to calculate the amount of his
monthly payment in the following manner:
Amount Requested ₱100,000
Credit investigation 500
Credit Risk Insurance 1,000
Total ₱101,500
Interest ( ₱101,500) (24) (0.015) = ₱36,540

Total Owed: ₱101,500 + 36,540 = ₱138,040
Payment = ₱138,040 = 5,751.67

24
What is the effective rate of interest of the loan?
Solution:
₱100,000
Property of and for the exclusive use of SLU. Reproduction,0storing1in a retrieval

2 system,
3 distributing, uploading or posting
23 online,
24 Mor transmitting in any form or by any
For EIR:
[ ]
−24
1−( 1+i )
₱100,000 = 5,751.67
i
i = 0.02758/month
EIR = [ 1 + r/m]m – 1 = [ 1 + i/month ] 12 - 1

EIR = [ 1+ .02758]12 -1 = .3861 x 100 = 38.61%/ year ans
2. Deferred Annuity
A deferred annuity is one where the first payment is made several periods after the beginning of the
annuity.
Finding P when A is Given
P
m periods n periods
0 1 2 n-1 n
0 1 2 m
A A A A
PA (P/F, i%, m) (P/i%, A (PA/A, i%, n)
m) PAA
To derive the formula of P for deferred, equation of values was again used,
using “0” as focal point
P = A (P/A, i%, n) (P/F, i%, m)
[ ]
−n
1−( 1+i )
P=A ( 1+i )−m
i
[ ( 1+i )n−1
]
F = A storing in a retrieval
Property of and for the exclusive use of SLU. Reproduction,
m
( 1+ i )system, distributing, uploading or posting online, or transmitting in any form or by any
i of any part of this document, without the prior written permission of SLU, is strictly prohibited. 43
means, electronic, mechanical, photocopying, recording, or otherwise
Example 5: A debt of ₱40,000, whose interest rate is 15% compounded semiannually, is to be discharged by
a series of 10 semiannual payments, the first payment to be made 6 months after consummation of the loan.
The first 6 payments will be ₱6,000 each, while the remaining 4 payments will be equal and of such amount
that the final payment will liquidate the debt. What is the amount of the last 4 payments?
Solution: i = r/m = 15%/2 = 7.5%/ SA
₱40,000
0 1 2 3 4 5 6 7 8 9 10
A A A A
₱6,000 (P/A, 7.5%, 6)
A (P/A, 7.5%, 4) (P/F, 7.5%, 6) A (P/A, 7.5%4)
Using “0” focal date, the equation of value is

₱40,000 = ₱6,000 (P/A, 7.5%, 6) + A (P/A, 7.5%, 4) (P/F, 7.5%, 6)
[ ] [ ]
−6 −4
1−( 1.075 ) 1−( 1.075 )
₱40,000 = ₱6,000 +A ( 1.075 )−6
.075 .075
₱40,000 = ₱6,000 (4.6938) + A (3.3493) (0.6480)
A = ₱5,454
Or Using “10” as focal pt
₱40,000(F/P, 7.5%,10) = ₱6,000 (A/F, 7.5%, 6) (F/P, 7.5%, 4) + A (F/A, 7.5%, 4)
₱40,000 ( 1.075 )10 = ₱6,000

[ ( 1.075 )6 −1
0.075 ]( 1.075 )4 + A [
( 1.075 ) 4−1
0.075 ]
A = ₱5,454
3. Annuity Due
A deferred annuity is one where the payments are made at the beginning of each period.
Finding P when A is Given
0 1 2 3 4 n-1 n
A A A A A A
P = A + A (P/A, i%, n-1)

P = A (1 + P/A, i%, n-1)
Finding F when A is Given
0 1 2 3 4 n-1 n
F = A (F/A, i%, n +1) – A
F = A [(F/A, i%, n-1) – 1]
Example 6 A man bought an equipment costing ₱60,000 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?
Solution:
24 %
P = ₱60,000 n = 12 i= =8 %
3
P = A (1+P/A, 2%, n-1)
₱60,000 = A (1+ P/A, 8%, 11)
₱60,000 = A (1+ 7.1390)
A = ₱7,371.91
Work on the following exercise. This is an opportunity for you to practice your knowledge and skills
you acquired in this unit. Final answers are provided at the end of each problem to serve as your guide.
Write the problem and solution in a short bond paper with heading Assignment M2.2 and submit.
1. A young woman, 22 years old, has just graduated from college. She accepts a good job and desires to
establish her own retirement fund. At the end of each year thereafter she plans to deposit ₱2,000 in a
fund at 15% annual interest. How old will she be when the fund has an accumulated value of
₱1,000,000? Ans: 53 years old
2. M purchased a small lot in a subdivision, paying ₱200,000 down and promising to pay ₱15,000
every 3 months for the next 10 years. The seller figured interest at 12% compounded quarterly.
(a) After making 8 payments, M wished to discharge his remaining indebtedness by a single payment
at the time when the 9th regular payment was due, what must he pay in addition to the regular
payment then due?
(b) If M missed the first 10 payments, what must he pay when the 11 th payment is due to discharge his
entire indebtedness?
Ans: (a) ₱300,006; (b) ₱479,948
3. A new office building was constructed 5 years ago by a consulting engineering firm. At the time the
firm obtained the bank loan for ₱10,000,000 with a 20% annual interest rate, compounded quarterly.
The terms of the loan called for equal quarterly payments for 10-year period with the right of
prepayment at any time without penalty.
Due to the 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 one-time service charge of 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 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) ₱7,262,733; (b) ₱120,862
4. 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 years 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. ₱79,245
MODULE 2
MONEY-TIME RELATIONSHIPS AND EQUIVALENCE
Unit 3
Perpetuity, Capitalized Costs and Uniform Arithmetic Gradient
 TLO 2.3: Solve varied applications involving singular cash flows and multiple cash flows
through proper use of interest and time concepts..
Diagnostic Test : Please answer the following questions and write your
answers on the space provided and submit your work in our Google
Classroom Under Diagnostic Test M2.3
What comes into your mind when you hear the word “Perpetuity”?
1. Perpetuity
A perpetuity is an annuity in which the payments continue indefinitely.
P
0 1 2 3 4 n ∞
A A A A
= ∑
P=A
[ 1−( 1+i )−n
i ] [
= A
1−( 1+i )−∞
i ]
A
P=
i
2. Capitalized Cost
One of the most important applications of perpetuity is in capitalized cost. The capitalized cost of any
property is the sum of the first cost and the present worth of all costs of replacement, operation and
maintenance for a long time or forever.
Case 1. No replacement, only maintenance and or operation every period.
Capitalized cost = First cost + Present worth of perpetual

operation and or maintenance
Case 2. Replacement only, no maintenance and or operation.
Capitalized cost = First cost + Present worth of perpetual

replacement
Let S = amount needed to replace a property every k periods
P = amount of principal invested at rate i% the interest on
which will amount to S every k periods
Example K = 3
P
0 1 2 3 4 5 6
∞
∞
S S
S S
∞
0 1 2 3 4 5 6
∞
A A A A A A
A = S(A/F, i%, k) = S
[ i
( 1+i )k −1 ]
P=
A
i
=
S i
[
i ( 1+i )k −1 ]
Case 3. Replacement, maintenance and or operation every period
Capitalized cost = First cost + Present worth of cost of

perpetual operation and or maintenance + Present worth of
cost of perpetual replacement
Example 1: What amount of money invested today at 15% interest can provide the following scholarships:
₱30,000 at the end of each year for 6 years; ₱40,000 for the next 6 years and ₱50,000 thereafter?
Solution:
₱ 50,000 ₱ 50,000
(P/F,
0.15 0.15
₱40,000 (P/A, 15%, 6)
(P/F, 15%,6) ₱40,000 (P/A, 15%, 6) ₱50,000 ₱50,000
∞
₱30,000 (P/A, 15%, 6) ₱40,000 ₱40,000 ₱40,000
₱30,000 ₱30,000 ₱30,000
0 1 2 6 7 8 12 13 14
Using today as the focal date, the equation of value is

₱ 50,000
P = ₱30,000 (P/A, 15%, 6) + ₱40,000 (P/A, 15%, 6) (P/F, 15%, 6) + (P/F, 15%, 12)
0.15
[ ] [ ]
−6 −6
1−( 1.15 ) 1−( 1.15 ) ₱ 50,000
P = ₱30,000 + ₱40,000 (1.15)-6 + (1.15)-12
.15 .15 0.15
₱ 50,000
P = ₱30,000 (3.7845) + ₱40,000 (3.7845) (0.4323) + (0.1869)
0.15
P = ₱241,277
Example 2: Determine the capitalized cost of a structure that requires an initial investment of ₱1,500,000 and
an annual maintenance of ₱150,000. Interest is 15%.
Solution: 1.5M A A
P P ∞
0 1 2
P = Capitalized Costs
A ₱ 150,000
= =¿₱1,000,000
i 0.15
Capitalized Cost = First cost + A/i
= ₱1,500,000 + ₱1,000,000
Capitalized Cost = ₱2,500,000
Example 3: A new engine was installed by a textile plant at a cost of ₱300,000 and projected to have a useful
life of 15 years. At the end of this useful life, it is estimated to have a salvage value of ₱30,000. Determine its
capitalized cost if interest is 18% compounded annually.
Solution: X
(isolate the cash flow of the replacement)
₱30,000 ₱30,000 ₱30,000
∞
0 15 30 45 0 15 30 45
∞ ∞
₱300,000 ₱300,000 ₱300,000 ₱300,000
₱270,000 ₱270,000 ₱270,000
S ₱ 270,000
X= = =¿₱24,604
( 1+i ) −1 ( 1+ 0.18 )15 −1
k
Capitalized Cost = First cost + X

= ₱300,000 + ₱24,604
Capitalized Cost = ₱324,604
3. Amortization
Amortization is any method of repaying a debt, the principal and interest included, usually by a series
of equal payments at equal interval of time.
Example 4: A debt of ₱5,000 with interest at 12% compounded semi annually is to be amortized by equal
semi annual payments over the next 3 years, the first due in6 months. Find the semi annual payment and
construct an amortization schedule.
Given: P = P5,000 n=3 yrs x 2 SA/yr = 6 SA r = 12% CSA i = 12%/2 = 6%/SA
Required: A and amortization table
Solution:
₱5,000
0 1 2 3 4 5 6
A A A A A A
A = 5,000
[ .06
1−( 1.06 )
−6
]
A = ₱1,016.82
Amortization table
C1 C2 C3 C4
Period (n) Outstanding Interest due at end Payment Principal repaid at
principal at of period end of period
beginning of period
1 ₱5,000 ₱300.00 ₱1,016.82 ₱716.82
2 4,283.18 256.99 ₱1,016.82 759.83
3 3,523.35 211.40 ₱1,016.82 805.42
4 2,717.93 163.08 ₱1,016.82 853.74
5 1,864.19 111.85 ₱1,016.82 904.97
6 959.22 57.55 ₱1,016.82 959.27
TOTALS ₱1,100.87 ₱6,100.92 ₱5,000.05
C1= C1n-1 – C4n-1 C2= C1*.06 C3= A C4 = C3-C2
4. Uniform Arithmetic Gradient
In certain cases, economic analysis problems involve receipts or disbursements that increase or
decrease by a uniform amount each period.
(n-1) G
3G 4G
A A A A A A 2G
G
0
= +
0 1 2 3 4 5 6 0 1 2 3 4 5 6
0 1 2 3 4 5 6
P PA PG
P = PA + PG
PA = A(P/A, i%,n) = A
[ 1−( 1+i )−n
i ]
[ ][ ]
n
G ( 1+i ) −1 1
PG = −n
i i ( 1+i )
n
[ ][ ]
n
1 ( 1+i ) −1 1
P/G, i%, n = −n
i i ( 1+i )
n
Example 5: A loan was to be amortized by a group of four end-of-year payments forming an ascending
arithmetic progression. The initial payment was to be ₱5,000 and the difference between successive payments
was to ₱400. 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: let A’ = annual payment
₱1200
₱5,400 ₱5,800 ₱5,000 ₱5,000 ₱5,000 ₱5,000
₱800 A’ A’ A’ A’
₱5,000 ₱6,200 ₱400
= + 0
=
0 1 2 3 4 0 1 2 3 4 0 1 2 3 4 0 1 2 3 4
P PA P P
Let A’ = the annual payment

A= ₱5,400 G = ₱400n= 4 i = 15%
[ ]
−4
1−( 1.15 )
P/A, 15%, 4 = = 2.8550
0.15
[ ][ ]
4
1 ( 1.15 ) −1 1
P/G, 15%, 4 = −4 4 = 3.7865
0.15 0.15 ( 1.15 )
P = A (P/A, 15%, 4) + G (P/G, 15%, 4)
= (₱5,400) (2.8550) + (₱400)(3.7865)
= ₱15,789.60
A’(P/A, 15%, 4) = ₱15,789.60
A’ = ₱5,530.51
Submit your work.
1. Calculate the capitalized cost of a project that has an initial cost of ₱3,000,000 and an additional
investment cost of ₱1,000,000 at the end of every ten years. The annual operating cost will be
₱100,000 at the end of every year for the first four years and ₱160,000 thereafter. In addition, there is
expected to be a recurring major rework cost of ₱300,000 every 13 years. Assume i = 15%. Ans:
₱4,281,990
2. The will of a wealthy philanthropist left ₱5,000,000 to establish a perpetual charitable foundation.
The foundation trustees decided to spend ₱1,200,000 to provide facilities immediately and to provide
₱100,000 of capital replacement at the end of each 5-year period. If the invested funds earned 12%
per annum, what would be the year-end amount available in perpetuity from the endowment for
charitable purpose? Ans: ₱440,259
3. A contract has been signed to lease a building at ₱200,000 per year with an annual increase of
₱1,500 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? Ans: ₱147,609
Write your answers in a short bond paper and submit your work in our Google Classroom under
classwork Quiz Assignment M2.
1. You borrow $5000 from a family member and agree to pay it back in 5 months. Because you are part
of the family, you are only being charged an interest at the rate of 0.5% per month. How much will
you owe after 6 months? How much is the interest? What is the effective interest rate? What is the
corresponding nominal rate?
2. What lump sum amount of interest will be paid on a P100,000 loan that was made on August 1, 1993,
and repaid on November 1, 1999, with ordinary simple interest at 12% per year?
3. A woman arranges to repay a P10,000 bank loan in 10 equal payments at a 10% effective annual
interest rate. Immediately after her third payment she borrows another P5000, also at 10%. When
she borrows the P5,000, she talks the banker into letting her repay the remaining debt of the first loan
and the entire amount of the second loan in 12 equal annual payments. The first of these 12 payments
would be made 1 year after she receives the P5,000. Compute the amount of each of the 12
payments.
4. Your rich uncle has just offered you to make you wealthy! For every amount you save in an insured
bank account during the next 10 years, he will give you the total amount (excluding interest) that you
saved to match it. Because your modest income permits you to save P2,000 per month for the next 10
years, your uncle will be willing to give you 240,000 at the end of the 10 th year. If you desire a total
of P1,00,000 10 years from now, what effective interest rate would you have to earn on your insured
bank account to make your goal possible?
5. Mr. Alhambra has instructed his bank to establish a trust fund that will provide P10,000 per year for
the first five years then P8000 per year for the next 10 years and then will provide P7,000 per year
thereafter to help pay for the upkeep on a memorial garden. The first of these payments would begin
on Jan1, 2009, He also wishes to provide P100,000 every 8 years for replacement to start Jan 1, 2015.
Suppose it is now Jan 1, 2004, how much should be in the trust fund today if interest rate is 5%
compounded annually?
6. A debt of ₱10,000 with interest at the rate of 20% compounded semiannually is to be amortized by 5
equal payments at the end of each 6 months, the first payment is to be made after 3 years. Find the
semiannual payment and construct amortization schedule.
End of Module 2 MODULE 3

Depreciation

 TLO 3: Understand the purpose of depreciation and to solve problem on depreciation.
Diagnostic Test.
Please read the questions and answer on the space provided. Submit
your answer under Diagnostic Test M3.
What is depreciation for you?
_____________________________________________________________________
_____________________________________________________________________
_____________________________________________________________________
_____________________________________________________________________
_____________________________________________________________________
_____________________________________________________________________
Cite example or situation in which depreciation is applicable.
____________________________________________________________________
____________________________________________________________________
____________________________________________________________________
Depreciation
 is the decrease in value of physical properties with the passage of time and use.
 depreciation is an accounting concept that establishes an annual deduction against before-tax

income such that the effect of time and use on an asset’s value can be reflected in a firm’s
financial statements.
 Is a noncash cost that is intended to “match” the yearly fraction of value used by an asset in
the production of income over the asset’s life. The actual amount of depreciation can never
be established until the asset is retired from service.
1. Definition of Value
Value, in a commercial sense, is the present worth of all future profits that are to be received through
ownership of a particular property.
 The market value of a property is the amount which a willing buyer will pay to a willing
seller of a property where each has equal advantage and is under no compulsion to buy or
sell.
 The utility or use value of a property is what the property is worth to the owner as an
operating unit.
 Fair value is the value which is usually determined by a disinterested third party in order to
establish a price that is fair to both seller and buyer.
 Book value, sometimes called depreciated book value, is the worth of a property as shown on
the accounting records of an enterprise.
 Salvage, or resale, value is the price that can be obtained from the sale of the property after it
has been used.
 Scrap value is the amount the property would sell for if disposed off as junk.
2. Purpose of Depreciation
 To provide for the recovery of capital which has been invested in physical property.
 To enable the cost of depreciation to be charged to the cost of producing products or services
that results from the use of the property.
3. Depreciation Methods
We shall use the following symbols for the different depreciation methods:
L = economic or useful life of the property in years
Co= the original cost (including shipping + installation cost)
CL= the value at the end of the life, the scrap/salvage value (including gain or loss due to
removal)
d = the annual cost of depreciation per year
Cn= the book value at the end of n years (C0 –Dn)
Dn= depreciation up to age n year/ total Depreciation or accumulated Depreciation
(a) The Straight Line Method
This method assumes that the loss in value is directly proportional to the age of the property.
d = (Co – CL) / L
Dn = n {(Co – CL) / L} = n(d)
Cn = Co – Dn
Example 1:
Power to a remote transmitting station is provided by a Diesel-Electric-Generator unit. The original
cost of the unit is P65,000. It cost P2000 to ship the unit to the job site. An additional cost of P3000
was incurred for installation. Determine the annual depreciation expense by the straight line method,
if the unit has an expected life of 10 years. The salvage value of the unit at the end of its life was
estimated at P5,000.
Given: Co = P65,000+2,000+3,000= P70,000
L = 10 years
CL = P5,000
Required:
d = annual cost of depreciation =?
Solution:
d = 70,000 – 5,000 d = P6,500 answer D2= 6,500 +6,500 = 13,000
10
(b) The Sinking Fund Formula

This method assumes that a sinking fund is established in which funds accumulate for
replacement. The total depreciation that has taken place up to any given time is assumed to be equal
to the accumulated amount in the sinking fund at that time.
d = (Co – CL) / (A/F , i%, L)

Dn = d(F/A , i%, L)
Cn = Co – Dn
Example 2:
Using the data found in Example 1, determine the annual depreciation expense by the sinking fund
formula. Assume that the annual depreciation charge was deposited in a fund drawing compound
interest at the rate of 5%.
i = 0.05/yr
d = (70,000-5,000) 0.05
(1.05) 10-1
d = 5, 167.80 answer
(c) Declining Balance Method
In this method, sometimes called the constant percentage method or the Matheson Formula, it
is assumed that the annual cost of depreciation, is a fixed percentage of the salvage value at the
beginning of the year. The ratio of the depreciation in any year to the book value at the beginning of
that year is constant throughout the life of the property and is designated by k, the rate of
depreciation.
Year Book value at beginning Depreciation during the Book value at the end of
of year year year
1 Co d1 = k Co C1 = Co – d1 = Co(1 – k)
2 Co(1 – k) d2 = k C1 C2 = C1 – d2 = Co(1 – k)2
3 Co(1 – k)2 d3 = k C2 C3 = C2 – d3 = Co(1 – k)3
… … … …
n Co(1 – k)n-1 dn = k Cn-1 Cn = Cn-1 – dn = Co(1 – k)n
… … … …
L Co(1 – k)L-1 dL = k CL-1 CL = CL-1 – dL = Co(1 – k)L
d = Co(1 – k)n-1 k
Cn = Co(1 – k)L = Co(CL – Co)n/L
CL = Co(1 – k)L
k=1-
√
n
Co √
Cn = 1 - L CL
Co
Note:
This method does not apply, if the salvage value is zero, because k will be equal to one and d 1 will be
equal to Co.
The K value can also be assumed by the owner. If in the problem the K value is not given then the
fomula will be used.
Example:
If the physical property considered has an original cost of P800,000 and a life of 5 years and is
assumed to be depreciated at the rate of 10% per year. Construct the depreciation schedule.
Given
C0 = P800,000
L = 5 years
K = 10 %
Solution
Depreciation Schedule:
Year Bookvalue at Depreciaton per Total depreciation Bookvalue at end

beginning of yr. year (d) (D) of year Cn
1 800,000 80,000 80,000 720,000
2 720,000 72,000 152,000 648,000
3 648,000 64,800 216.800 583200
4 583,200 58,320 275.120 524,880
5 524,880 52488 327,608 472,392
Sample computation using table and using formula
d1 = 10% (800,000) = P80,000 or d1 = 800,000(1-.10)0(.10)= 80,000
d3 = 10% (648,000) = P64,800 or d3 = 800,000(1-.10)2 (.10) =64,800
D2 = d1 + d2 = 80,000 + 72,000 = 152,000
C2 = C0 – Dn = 800,000 – 152,000= 648,000 or

C2 = 800,000 (1-.10)2 = 648,000
(d) Double Declining Balance (DDB) Method
This method is very similar to the declining balance method except that the
rate of depreciation k is replaced by 2/L.
2 n-1 2
d = Co (1 - )
L L
2 n
Cn = Co (1 - )
L
2
CL = Co (1 - )L
(e)
L
The Sum-of-the-Years’-Digits (SYD) Method
Let dn = depreciation charge during the nth year

dn = (depreciation factor) ( total depreciation)
reverse digit
dn = (C – C )
∑ of digits o L
Example :
Construct the depreciation schedule of an equipment that costs P 800,000 with a 5 year life and a
salvage value of P100,000.
Solution:
Depreciation Schedule
Year Year in Reverse Depreciation Depreciation Total Bookvalue at

factor per year Depreciation end of year
1 5 5/15 233,333 233,333 566,667
2 4 4/15 186,667 420,000 380.000
3 3 3/15 140,000 560,000 240,000
4 2 2/15 93,333 653,333 146,667
5 1 1/15 46,667 46,667 100,000
Sum= 15
(f) The Service – Output Method

This method assumes that the total depreciation that has taken place is directly proportional to
the quantity of output of the property up to that time. This method has the advantage of making the
unit cost of depreciation constant and giving low depreciation expense during periods of low
production.
Let T = total units of output up to the end of life

Qn = total number of units of output during the nth year
(C o – C L)
Property of and for the exclusiveDepreciation per unitstoring
use of SLU. Reproduction, of output = system, distributing, uploading or posting online, or transmitting in any form or by any
in a retrieval
T document, without the prior written permission of SLU, is strictly prohibited. 63
means, electronic, mechanical, photocopying, recording, or otherwise of any part of this
(C o – C L)
dn = (Qn)
Example:
Construct the depreciation schedule of an equipment with original cost of P500,000 and a salvage
value of P200,000 and a life of 4 years, using service output method if the maximum units it can
produce is 1,000,000 units of product. The quantity produced per year are as follows: Year 1
200,000 units, Year 2 150,000 units, Year 3, 300,000, Year 4 350,000.
Given:
T = 1,000,000
Co = P500,000
CL = 200,000
L = 4 years
Solution:
Depreciation per unit = 500,000 -200,000 = 0.30 per unit
1,000,000
Year Qn Depreciation Total Book value at

per year Depreciation end of year
1 200,000 60,000 60,000 440,000
2 150,000 45,000 105,000 395,000
3 300,000 90,000 195,000 305,000
4 350,000 105,000 300,000 200,000
Total 1,000,000 300,000
Example 1: An electronic balance costs ₱90,000 and has estimated salvage value of ₱8,000 at the end of its
10 years’ life time. What would be the book value after three years, using the straight line method in solving
for the depreciation?
Solution:
Co = ₱90,000 CL = ₱8,000 L = 10 n=3
d = (Co – CL) / L = (₱90,000 - ₱8,000) / 10 = ₱8,200
Dn = (n) (d) = (3) (₱8,200) = ₱24,600
Cn = Co – Dn = (₱90,000 - ₱24,600) = ₱65,400
Example 2: A broadcasting corporation purchased an equipment for ₱53,000 and paid ₱1,500 for freight and
delivery charges to the job site. The equipment has a normal life of 10 years with a trade-in value of ₱5,000
against the purchase of a new equipment at the end of life.
(a) Determine the annual depreciation cost by the straight line method.
(b) Determine the annual depreciation cost by the sinking fund method. Assume interest at 6-1/2%
compounded annually.
Solution:
Co = ₱53,000 + ₱1,500 = ₱54,500
CL = ₱5,000
(a) d = (Co – CL) / L = (₱54,500 - ₱5 ,000) / 10 = ₱4,950

(b) d = (Co – CL) / (F/A,i%,L) = (₱54,500 - ₱5 ,000) / (13.3846) = ₱3,668
Example 3: A certain type of machine loses 10% of its value each year. The machine costs ₱2,000.00
originally. Make out a schedule showing the yearly depreciation, the total depreciation and the book value at
the end of each year for 5 years.
Solution:
Year Book value at Depreciation during Total depreciation at Book value at the
beginning year the year 10% the end of year end of year
1 ₱2,000.00 ₱200.00 ₱200.00 ₱1,800.00
2 1,800.00 180.00 380.00 1,620.00
3 1,620.00 162.00 542.00 1,458.00
4 1,458.00 145.80 687.80 1,312.20
5 1,312.20 131.22 819.12 1,180.98
Example 4: Determine the rate of depreciation, the total depreciation up to the end of the 8 th year and the
book value at the end of 8 years for an asset that costs ₱15,000 new and has an estimated scrap value of
₱2,000 at the end of 10 years by the double declining balance method.
Solution:
Rate of depreciation = 2/ L = 2 / 20 = 0.20 or 20%
2 n 2 8
Cn = Co (1 - ) = ₱15,000 (1 - ) = ₱2,517
L 10
Dn = Co – CL = ₱15,000 – ₱2,517 = ₱12,483
Example 5: A structure costs ₱12,000 new. It is estimated to have a life of 5 years with a salvage value at the
end of life of ₱1,000. Determine the book value at the end of each year of life.
Solution:
Co – CL = ₱12,000 – ₱1,000 = ₱11,000
Year Year in Depreciation during the year Book value at end of
Reverse year
order
1 5 (5/15) (₱11,000) = ₱3,667 ₱8,333
2 4 (4/15) (₱11,000) = 2,933 5,400
3 3 (3/15) (₱11,000) = 2,200 3,200
4 2 (2/15) (₱11,000) = 1,467 1,733
5 1 (1/15) (₱11,000) = 733 1,000
∑ of digits=15
Work on the following exercise in a short bond paper. This is an opportunity for you to practice your
knowledge and skills you acquired in this unit. Final answers are provided at the end of each problem
to serve as your guide.
1. A machine shop purchased 10 years ago a milling machine for ₱60,000. A straight-line depreciation
reserve had been provided on a 20 year life of the machine. The owner of the machine shop desires to
replace the old milling machine with a modern unit of many advantages costing ₱100,000. It can sell
the old unit for ₱20,000. How much new capital will be required for the purchase? Ans: ₱50,000
2. A tax and duty free importation of a 30 HP sandmill (for paint manufacturing) cost ₱360,000,
CIF Manila. Bank charges, arrastre ₱25,000. Other incidental expenses amounted to ₱20,000.
Salvage value of the mill is estimated to be ₱60,000 after 20 years. Find the appraisal value of the
mill, using straight-line depreciation, at the end of (a) 10 years and (b) 15 years? Ans: (a) ₱235,000
(b) ₱147,500
3. An industrial plant bought a generator set for ₱90,000. Other expenses including installation
amounted to ₱10,000. The generator set is to have a life of 17 years with a salvage value at the end of
life of ₱5,000. Determine the depreciation charge during the 13 th year and the book value at the end
of 13 years by the (a) declining balance method, (b) double declining balance method, (c) sinking
fund method at 12% and (d) SYD Method. Ans: (a) ₱1,949; (b) ₱2,620; ₱19,649; (c) ₱1,943;
₱45,539; (d) ₱3,105; ₱11,209
Work on the following problems which will be submitted file heading Quiz Assignment M3.
Requirement for assignments are it should be hand written, neat and complete with problem, given,
solution and final answers properly enclosed in a box.
1. During the construction of a highway bypass, earth moving equipment costing P400,000 was
purchased for use in transporting fill from the borrow pit. At the end of the 4-year project, the
equipment will be sold for P200,000. The schedule for moving fill calls for a total of 100,000 cubic
feet during the project. In the first year, 40% of the total fill is required; in the second year, 30%; in
the third year 25%; and in the final year, the remaining 5%. Determine a) the units-of-production
depreciation schedule b) the declining balance depreciation schedule.
3. A central air conditioning unit was installed on January 1, 2000 at an initial cost of P650,000 and was
expected to have a salvage value of P50,000 after a life of 7 years.
a. What amount of depreciation had accumulated in a sum-of-the-years’-digit method at the end
of 2003?
b. Using the declining balance method, determine the depreciation charged for 2004 and the
bookvalue at the end of 2004
c. If the equipment was sold on Jan 1, 2005 for P100,000, what amount of loss would result
from this sale if sinking fund method was being used with interest of 12% per year?
End of Module 3
MODULE 4
BASIC ECONOMIC STUDY METHODS
 TLO 4: Evaluate the financial viability of an engineering project using different economy study
methods.
Evaluating a Single Project
Carbon Fibers versus Metal
There is a rule-of-thumb that “if the weight of an automobile can be reduced by 10%, then
6% of the annual cost of gasoline can be saved.” Light weight and high strength carbon
fibers costing about $15-$20 per pound are currently being considered to replace the metal
in automobile and aerospace applications. (The objective of recent research is to reduce
this cost to$5 per pound.) Engineers believe they can economically reduce the weight of an
automobile by substituting carbon fibers for metal to save 20% to 30% on fuel consumption
each year. Other structures such as stronger wind turbines can also be built with light
weight carbon fibers. After working through this module, you will be able to evaluate the
economic trade-off between annual fuel savings and up-front cost of carbon fibers and to
determine whether it is a smart trade-off.
Basic Methods for Making Economy Studies
- All economy studies of capital projects should be made so as to include consideration of the return
that a given project will or should receive.
- A basic question is whether a proposed capital investment and its associated expenditures can be
recovered by revenue/income (or savings) over time.
- Because patterns of capital investment, revenue (or savings) cashflows, and disbursement cash flows
can be quite different in various projects, there is no single method for performing engineering
economic analyses that is ideal for all cases. Consequently, several methods are commonly used.
Factors to be considered in Financial Studies:
1. Capital Required
Total Capital (investment)
a. Fixed Capital
b. Working Capital (Funds)
2. Expected Annual Income/Savings = (Selling Price) * (No. of units sold)
a. kind of good or service
b. no. of units to be sold
c. selling price (cost + mark-up)
3. Estimated Annual Expense
 Operating expenses (rent, utilities, salary, etc.)

 Maintenance
 Taxes and Insurance
 Depreciation
(a) Rate of Return (ROR Method)
Measures the financial effectiveness of an investment or how efficiently companies utilize
resources.
ROR = Net Annual Profit / Investment

Net Annual Profit or Savings =
Annual Income – Annual Expenses
Criterion: If the computed ROR is greater than or equal to
MARR then project is justified.
MARR = Minimum Attractive Rate of Return
The minimum attractive rate of return (MARR) is usually a policy issue resolved by
the top management of an organization in view of numerous considerations. These are the following
considerations:
1. The amount of money available for investment, and source and cost of these funds.
2. The number of good projects avaiable for investment and their purpose.
3. The amount of risk that is associated with investment opportunities available to the firm
4. The type of organization involved
(b) Annual Worth (AW) Method
Here, the minimum required profit or MRP is included as a cost.
MRP = Investment * MARR

Net AW = Annual Income or Savings – Annual Expenses –
MRP
Criterion: If net AW ≥ 0, then project is justified
Pattern of Method:
Annual income ₱ xxx
Less Annual Cost
Operating Cost xxx
Maintenance xxx
Taxes & Insurance xxx
Depreciation xxx
MRP = MARR (Investment) xxx xxx
Net Annual Worth (net AW) ₱ xxx
(c) Present Worth (PW) Method
Based on the concept of equivalent worth of all cash flows relative to some base or beginning
point in time called the present. That is, all cash inflows and outflows are discounted to the present
point in time at an interest rate that is generally the MARR.
Net PW = PW of cash inflow – PW of cash outflow
Criterion: If net PW ≥ 0, then project is justified
(d) Future Worth (FW) Method

This method is similar to the Present worth method except that, this is based on the concept
of equivalent worth of all cash flows relative to some future point in time. That is, all cash inflows
and outflows are discounted to the future point in time, usually at the end of life of the project, at an
interest rate that is generally the MARR.
Net FW = FW of cash inflow – FW of cash outflow

Criterion: If net FW ≥ 0, then project is justified
(e) Payback or Payout Period Method

All method thus far reflects the profitability of a proposed project. The Payback method
mainly indicates liquidity rather than its profitability. It measures the project’s riskiness, since
liquidity deals with how fast an investment can be recovered.
Investment −SalvageValue
Payback Period =
Net Annual Cashflow
(f) Internal Rate of Return (IRR) Method

Based only on a project’s cash flows, which is the basis of the internal. As the interest rate
that makes the NPW = 0, it is the projects rate of return. The IRR measures the attractiveness of a
single project.
With the i unknown (i=IRR),
NPW= 0 = PW of cash inflow – FW of cash outflow
Criterion: If computed IRR ≥ MARR, then project is justified
(g) External Rate of Return (ERR) Method
- it directly takes into account the interest rate () external to a project at which net
cash flows generated (or required) by the project over its life can be reinvested (or borrowed)
- in general three steps are used in the calculating procedure:
1st step - all net cash outflows are discounted to time zero (the present) at %
per compounding period.
2nd step - Second, all net cash inflows are compounded to period N at %.
3rd step – the ERR, which is the interest rate that establishes equivalence
between two quantities is determined. The absolute value of the present equivalent worth of the net
cash outflows at %.(first step) is used in this last stepp. In the equation form, the ERR is the at
which
Graphically, we have the following (the numbers relate to the three steps):
A project is acceptable when of the ERR method is greater than or equal to the firm’s MARR.
Criterion: If computed ERR ≥ MARR, then project is justified
Example 1: The owner of a theater plan to install an air conditioning system. They expect attendance to
increase by 50 persons a day with an average charge of ₱150/person. The theater operates 360 days per year.
Other data are as follows:
First cost of air conditioning system ₱1,500,000
Operating Cost ₱1,800/ day
Maintenance Cost ₱60,000/ year
Estimated Life 10 years
Taxes and Insurance 5%
Salvage Value 10%
Minimum Attractive Rate of Return 18%
Solution: Using ROR Method

1st solve for Net Annual Profit:
Annual Income ( person

₱ 150
) ( 50 persons
day )( year )
360 days
₱2,700,000
Less: Annual Expenses
Operating Cost ( ₱ 1,800

day ) ( year )
360 days
₱648,000
Maintenance 60,000
Taxes & Insurance (0.05) (₱1,500,000) 75,000
Depreciation ( 1.5M – 0.1(1.5M)) ( 1.180.18 )

10−1 57,394.77
Net Annual Profit ₱ 1,858,605.23
2nd substitute given investment and computed net annual profit to formula
Net Annual Profit ₱ 1,858,605.23
ROR = = * 100% = 123.97% > 18%
Investment ₱ 1,500,000
Conclusion: Since the computed ROR of 124% is greater than 18% therefore, the installation of
the air conditioning system is justified.
Example 2: Using the previous example in the ROR Method about the installation of the air conditioning
system:
Solution: Using AW Method
1st solve for the net Annual cost then compare net AW to zero
Annual Income ( person

₱ 150
) ( 50 persons
day )( 360yeardaus ) ₱2,700,000
Less: Annual Cost
Operating Cost ( ₱ 1,800

day ) ( year )
360 daus
₱648,000
Maintenance 60,000
Taxes & Insurance (0.05) (₱1,500,000) 75,000
Depreciation 57,394.77
MRP (0.18)(1.5M) 270,000 1,110,394.77
Net Annual Worth ₱ 1,589,605.23 > 0
Conclusion: Since the net AW of ₱ 1,589,605.23 is greater than zero therefore, then installation
of the air conditioning system is justified.
system:
Solution: Using PW Method: Make the cashflow diagram of the problem then solve the Net PW by
using “0” as focal point.
₱150,000
₱150(50) (360)= ₱2,700,000
0 10
₱648,000 + 60,000+75,000=₱783,000
₱1.5M
Note: Do not include depreciation expense in
the cash outflow because this expense does not
involve cash transaction.
( ) ( )
−10 −10
1−1.18 1−1.18
Net PW = 2.7M + 150,000 (1.18)-10 – 1.5M – 783,000
0.18 0.18
= ₱7,143,823.10 > 0
Conclusion: Since the net PW of ₱7,143,823.10 is greater than zero therefore, the installation of
system:
Solution: Using FW Method
₱150,000
₱150(50) (360)= ₱2,700,000
means, electronic, mechanical, photocopying, recording, or otherwise of any part of this document, without the10prior written permission of SLU, is strictly prohibited. 75
0
₱648,000 + 60,000+75,000=₱783,000
₱1.5M
Net FW = 2.7M ( 1.1810−1

0.18 )
+ 150,000 – 1.5M (1.18)10 – 783,000
1.1810−1
0.18 ( )
= ₱37,389,595.32 > 0
Conclusion: Since the net FW of ₱37,389,595.32 is greater than zero therefore, the installation of
system:
Solution: Using Payback Period
₱150,000
₱150(50) (360)= ₱2,700,000
Salvage Value
0 10
₱648,000 + 60,000+75,000=₱783,000
₱1.5M
Investment
Payback period=(Investment −Salvage Value
Net Annual Cashflow )
Payback period=(
2.7 M −783,000 )
1.5 M −150,000
= 0.70424 year (12 mo/year) = 8.45 months
Conclusion: Since the payback period is within a year after investment meaning after 8.45 months the
net cash flow is pure profit. Therefore, the installation of the air conditioning system is justified.
system:
Solution: using IRR (Solution is similar to PW method except that Net PW is equal to zero and solve for i
which is the IRR)
₱150,000
₱150(50) (360)= ₱2,700,000
0 10
₱648,000 + 60,000+75,000=₱783,000
₱1.5M
Note: Do not include depreciation expense in

the cash outflow because this expense does not
involve cash transaction.
( ) ( )
−10 −10
1−(1+ i) 1−(1+ i)
Net PW= 0 = 2.7M + 150,000 (1+ i)-10 – 1.5M – 783,000
i i
0= 1,917,000 ( 1−(1+ i)−10

i )
+150,000 (1+ i)-10 – 1.5M
i =
Example 7: Suppose that Ralph invest P300000 in a Series E savings bond that is cashed in 10 years later for
P500,000. What is the IRR for this investment?
Solution: Using IRR Method
The first step is to make the cashflow diagram.
P500,000
0 10
P300,000
As shown in the cashflow diagram, only the P and an F are involved. The unknown IRR the equates
the two cash flows can be found by the equation
Net PW= PW of cash inflow – PW of cash outflow
With Net PW = 0 then solve for i. The computed i = IRR

Criterion: If the computed IRR is greater than or equal to MARR then the project is justified.
Net PW = 0 = -300,000+ 500,000(1+IRR)-10
IRR = 10√ (500/ 300) – 1 = 5.24%
Example 8: A piece of new equipment has been proposed by engineers to increase the productivity of a
certain manual welding operation. The investment cost is $ 25,000, and the equipment will have a market
value of $5,000 at the end of a study period of five years. Increased productivity attributable to the equipment
will amount to $8,000 per year after extra operating costs have been subtracted from the revenue generated by
the additional production. If the firm’s MARR is 20% per year, is this proposal a sound one?
Solution: Using ERR suppose that % = MARR = 20 % per year
$5,000
A = $8,000
0 1 2 3 4 5
$ 25,0000
Using the equation under ERR method

$25,000 (F/P, , 5) = 8,000 (F/A, 20%, 5)+ $5,000
$64,532.80
(F/P, , 5) = -------------------------------- = 2.5813= (1+ i’ ) 5
$25,000
i ‘ = 20.88% > 20%
Conclusion: since the ERR is greater than 20%, therefore , the project is justified.
Example 9
When  = 15% and MARR = 20% per year, determine whether the project (whose net cash-flow diagram
appears next) is acceptable. Notice that in this example that the use of an % different from the MARR is
illustrated. This might occur if, for some reason, part or all of the funds related to a project are “handled”
outside the firm’s normal capital structure.
$5,000
0 in a 1retrieval system,
Property of and for the exclusive use of SLU. Reproduction, storing 2 3 4uploading
distributing, 5 or posting
6 online, or transmitting in any form or by any
Solution E0 = $10,000 (K=0),
E1= $ 5,000 (K=1).
Rk = $5,000 for k= 2,3,4,5,6 (deferred annuity)
$10,000
{10,000+ 5,000 (1.15) }( 1 + i') = 5,000

-1 ( 1.15 )5 −1
6
.15 [ ]
i' = 15.3% = ERR
Conclusion: since the i' is less than the MARR of 20%, therefore, this project would be
unacceptable according to the ERR method.
Work on the following exercises using all methods applicable to the problem. This is an opportunity for
you to practice your knowledge and skills you acquired in this module. Final answers are provided at
the end of each problem to serve as your guide. Write your work in a short bond paper under
Assignment M4
1. A young mechanical engineer is considering establishing his own small company. An investment of
₱400,000 will be required, which will be recovered in 15 years.
It is estimated that sales will be ₱800,000 per year and that operating expenses will be as follows:
Materials ₱360,000 per year
Labor ₱280,000 per year
Overhead ₱40,000 + 10% of sales per year
Selling Expense ₱60,000 per year
The man will give up his regular job paying ₱216,000 per year an devote full time to the operation of
the business; this will result in decreasing labor cost by ₱40,000 per year, material cost by ₱28,000
per year and overhead cost by ₱32,000 per year. If the man expects to earn at least 20% of his capital,
should he invest?
Ans: The man should not invest.
2. A food processing plant consumed 600,000 kwh of electric energy annually and pays an average of
₱2.00 per kwh. A study is being made to generate its own power to supply the plant the energy
required, and that the power plant installed would cost ₱2,000,000. Annual operation and
maintenance, ₱800,000. Other expenses, ₱100,000 per year. Life of power plant is 15 years; salvage
value at the end of life is ₱200,000; annual taxes and insurance, 6% of first cost; and rate of interest is
15%. Using the sinking fund method for depreciation, determine if the power plant is justifiable?
Ans: Rate of return is 7.11%, the power plant is not a good investment.
3. A fixed capital investment of ₱10,000,000 is required for a proposed manufacturing plant and an
estimated working capital of ₱2,000,000. 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 if the
annual profit is ₱2,500,000. Ans: 12.50%, 4.8 years
Work on the following problems using all applicable methods. Write your work in a short bond paper
under Quiz Assignment M4
1. It is estimated that insulation of steam pipes in a factory will reduce fuel bill by as much as 20%. The
cost of insulation is P9,000 and the cost of taxes and insurance is 5% of the initial cost. Without the
insulation, the annual fuel bill is P18,000. If the insulation is worthless after 6 years and a minimum
of 12% is desired, would it be worthwhile to invest in the insulation?
2. The ABC company is considering constructing a plant to manufacture a proposed new product. The
land costs P15,000,000, the building costs P30,000,000, the equipment costs P12,500,000, and
P5,000,000 working capital is required. At the end of 12 years, the land can be sold for P25,000,000,
the building for P12,000,000, the equipment for P250,000 and all of the working capital recovered.
The annual disbursements for labor, materials, and all other expenses are estimated to costs
P23,750,000. If the company requires a minimum return of 25%, what should the minimum annual
sales for 12 years to justify the investment?
End of Module 4
MODULE 5
DECISIONS UNDER CERTAINTY- Evaluation of Alternatives
 TLO 5: Compare projects that require different amounts of capital, annual revenues and costs in
order to recommend the best use of capital
Alternatives for Waste Storage
A larger electric utility company is considering two methods for containing and storing its coal
combustion by-products (fly ash). One method is wet slurry storage and the second method is
dry storage of the fly ash. The company will adopt one of these methods for all 28 fly ash
impoundments at its seven coal-fired power plants. Wet storage has an initial capital investment
of $2 billion, followed by annual maintenance expense of $300 million over the 10-year life of
the method. Dry storage has a $2.5 billion capital investment and $150 million per year annual
upkeep expenditure over its 7 year life. If the utility’s MARR is 10% per year, which method of
fly ash storage should be selected assuming an indefinitely long study period?
Based on the problem, what would you choose and why? Write your answer in the Google
classroom under classwork Engage Question M5.1.
Comparison and Selection Among Alternatives
- Most engineering projects can be accomplished by more than one feasibility design alternative.
- When the selection of one of these alternatives excludes the choice of any of the others, the
alternatives are called mutually exclusive.
Fundamental principle:
The alternative that requires the minimum investment of capital and produces satisfactory functional results
will always be chosen unless the incremental capital associated with an alternative having a larger investment
can be justified with respect to its incremental benefits
Methods or Patterns in Comparing Alternatives:
(a) Rate of Return on Additional Investment Method
Measures the financial effectiveness of an investment or how efficiently companies utilize
resources.
ROR on additional investment = Annual Net Savings for

choosing larger investment / Additional Investment
Criterion: If the rate or return on additional investment is
satisfactory, then, the alternative requiring a bigger
investment is more economical and should be chosen.
(b) Annual Cost Method (AC)

To apply this method, compute the annual cost of the alternatives by including interest on
investment. The alternative with least Total Annual Costs (TAC) is chosen.
(c) Equivalent Uniform Annual Cost Method (EUAC)
1 Draw cash flow diagram of each alternative
2 Compute for the EUAC of each alternative by converting all cash flows to its equivalent
uniform annual costs
3 Choose the alternative with least EUAC
(d) The Present Worth Cost (PWC) method

For this method, the PWC of each alternative is computed by solving for the present worth of
the net cash outflows of the alternatives for the same period of time.
* When the lives of the mutually exclusive alternatives are the same, the criteria to select the
best alternative are simple and intuitively clear. Those criteria are to choose the alternative with the
largest Equivalent Annual Worth or the alternative with the smallest or minimum Equivalent Annual
Costs.
* In case that the alternatives have different lives, then the alternatives should be compared
for the same number of years by solving to the least common multiple of their lives with the
assumption that each alternative repeat itself over time with the same costs and benefits.
Example 1: It is proposed to place a cable on an existing pole line along the shore of a lake to connect two
points on opposite sides.
Land Route Submarine Route
Length, miles 10 5
First cost of cable per mile ₱40,000 ₱68,000
Annual maintenance per mile 950 3,500
Interest on investment 18% 18%
Taxes 3% 3%
Net salvage value per mile 12,000 22,000
Life, years 15 15
Which is more economical?
Solution: Using ROR on Additional Investment
Investment ₱40,000 (10) = ₱400,000 ₱68,000 (5) = ₱340,000
Annual Expenses:
Maintenance 950 (10) = 9,500 3,500 (5) = 17,500
Taxes 3% (400,000) 3%(340,000)
Depreciation 4,592.78a 3,772.63b
Total Annual Expense ₱26,082.78 ₱31,472.63
a
(400,000 – 120,000) ( 0.18
15
1.18 −1 )
= 4,592.78
b
(340,000 – 110,000) ( 1.180.18−1 ) =
15 3,772.63
₱ 31,472.63−₱ 26,082.78
ROR on Additional Investment in Land Route = * 100% = 8.97% < 18%
₱ 400,000−₱ 340,000
Land route is more expensive but is annual expense if
cheaper so there is savings every year.
Note: in the computation of the depreciation expense, the sinking fund method is usually used unless
specified otherwise in the problem.
Conclusion: Since the rate of return of 8.97% is less than 18%, therefore submarine route is better. Meaning,
it is better to invest in submarine route worth P340,000 and spend P31,472.65 per year thus freeing the
P60,000 (supposedly additional investment when land route is chosen instead of submarine route) will be
used in other projects possibly earning 18% (.18 of P60,000=P10,800) compared to the net savings earned in
selecting Land Route only earning 8.97% (or .0897 of 60,000= P5,382).
Solution: Using Annual Cost Method (AC)
* the pattern of this method is almost similar to ROR on additional investment method but the only
difference is the addition of Interest of investment to get the total annual cost.
Annual Cost:
Maintenance 9,500 17,500
Taxes 12,000 10,200
Depreciation 4,592.78 3,772.63
Interest on Investment (0.18)(400,000) = 72,000 (0.18)(340,000) = 61,200
Total Annual Cost ₱98,092.78 > ₱92,672.63
Conclusion: Since TACSub < TACLand , Choose submarine route because it provides the least
TAC.
Solution: Using EUAC (draw the cashflow diagram of the alternatives and solve for the equivalent
annuity of the cashflow)
LAND ₱120,000 SUBMARINE ₱110,000
0 10 0 10
₱9,500 + 12,000 ₱17,800+10,200

₱400,000 ₱340,000
EUACLand = 400,000 ( 0.18

1−1.18 )
−15 + 21,500 – 120,000
0.18
1.1815−1❑ (
= 98,092.78 )
EUACSub = 340,000 ( 1−1.18
0.18
) −15 + 27,700 – 110,000 ( 1.180.18−1 )
15 ❑ = 92,672.63
Conclusion: Choose submarine route because it has the least EUAC.

Solution: Using PWC ( just like in EUAC method draw the cashflow diagram and solve for PWC)
Based on the cash flow diagram found in the EUAC Method:
( )
−15
1−1.18
PWCLand = 400,000 + 21,500 – 120,000(1.18)-15 = 499,446.99
0.18
( 1−1.18
0.18 )
−15
PWCSub = 340,000 + 27,700 – 110,000 (1.18)-15 = 471,849.93
Conclusion: Choose submarine route because it has the least PWC.

Example 2: An industrial plant is considering the purchase of centrifugal pump. Three offers were received
and basis for selection have been tabulated as follows:
A B C
Price of pump 60,000 96,000 120,000
Economic Life, years 3 5 10
Salvage value 5,000 10,000 8,000
Yearly Maintenance 10,000 6,000 5,000
If cost of money is 14%, what offer would you recommend to be purchased?
This is a case of a problem that we are dealing with alternatives with different lives
Solution: Using ROR on Additional Investment
Step 1. Compare Investment and Annual expenses of the alternatives
A B C
Investment 60,000 96,000 120,000
Annual Expenses:
Maintenance 10,000 6,000 5,000
Depreciation 15,990.23 13,010.385 5,791.92
(Co – CL)
( 1.140.14−1 )
L
Total Annual Expenses ₱25,990.23 ₱19,010.385 ₱10,781.92
Step 2. Solve for the ROR on additional investment of two different alternatives at a time using the formula.
 Comparing A & B
₱ 25,990.23−₱ 19,010.385
ROR on Additional Investment on B = * 100% = 14.39% > 14%
₱ 96,000−₱ 60,000
; Choose B because the rate of return on
additional investment in Alt B is greater that
14% interest of investment
* the next, therefore, is to compare B and C. Alternative A is already eliminated from
choice.
 Comparing B & C
₱ 19,010.385−₱ 10,781.92
ROR on Additional Investment on C = * 100% = 34.24% > 14%
₱ 120,000−₱ 96,000
; Choose C
Conclusion: Among the three alternatives, choose Alternative C because based on computations when
alternatives A and B were compared, Alt B is better than A since the ROR on additional investment of using
Alternative B is higher than the interest on investments of 14% thus Alternative A was eliminated from
choice. But when Alt B and Alt C were compared, even if Alt C has the higher investment, the ROR on the
savings gained from using Alt C is greater than the interest on investments of 14%, therefore Alt C is better
than Alt B.
Solution Using Annual Cost Method (AC)
A B C
Annual Cost:
Maintenance 10,000 6,000 5,000
Depreciation 15,990.23 13,010.385 5,791.92
Interest on Investment 8,400 13,440 16,800
(0.14)(Investment)
Total Annual Cost ₱34,890.23 ₱32450.38 ₱27,591.92
Conclusion: Choose pump C because it has the least TAC.
Solution using EUAC:

In the EUAC method, construct the cash flow diagram of each alternative considering their respective lives (3
years, 5 years, and 10 years), then compare their computed EUAC. The alternative with least EUAC will be
chosen.
Solution: Using PWC Method

In the PWC method, construct the cash flow diagram of each alternative by first determining the least
common multiple of their respective lives (3 years, 5 years, and 10 years) which is 30 years, then compute
their PWC. The alternative with least PWC will be chosen.
* The assumption is Alt A will be purchased 10 times, Alternative B will be purchased 6 times and
Alternative C 3 times. Notice, too that in the cashflow, everytime a new pump is purchased the
salvage value is already deducted from the price of the pump.
Work on the following exercise using all methods . This is an opportunity for you to practice your
knowledge and skills you acquired in this unit. Final answers are provided at the end of each problem
to serve as your guide. Write your solution in a short bond paper and submit your work with heading
Assignment M5
1. In a cold storage plant, it is desired to determine whether to use insulation two inches thick or three
inches in insulating the walls of the cold storage warehouse. Heat absorbed through the walls without
insulation would cost ₱96.00 per year per square meter. A two-inch insulation will cost ₱30.40 per
square meter and will cut out 89% of the loss. A three-inch insulation will cut out 92% of the loss and
will cost ₱65.00 per square meter. Using a life of 15 years for the insulation with no salvage value
and a minimum attractive return of 8%, what thickness of insulation should be used? Ans: 2-in thick
insulation
2. An electric cooperative is considering the use of a concrete electric pole in the expansion of its power
distribution lines. A concrete pole costs ₱18,000 each and will last 20 years. The company is
presently using creosoted wooden poles which cost ₱12,000 per pole and will last 10 years. If money
is worth 12 per cent, which pole should be used? Assume annual taxes amount to 1 per cent of first
cost and zero salvage value in both cases. Ans: The creosoted wooden poles should be used.
3. An oil company is being offered a special coating for the gasoline underground tank installation in its
service stations which will increase the life of the tank from the usual 10 years to 15 years. The cost
of the special coating will increase the cost of the P40,000-tank to P58,000. Cost of installation for
either of the tanks is P24,000. If the salvage value for both tank is zero and interest rate is 20%,
would you recommend the use of special coating? Special coating should not be used.
End of Module 5
MODULE 6
DECISIONS UNDER CERTAINTY- After-Tax Analysis and Inflation
 TLO 6: To solve decision analysis problems involving taxes and inflation.
Diagnostic Test M5.2: Answer the following questions in your own

words in the space provided below.
What is Income tax? Will this affect the decision analysis of engineering projects?
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What is inflation? How will this affect the economic analysis of engineering projects?
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AFTER-TAX ANALYSIS
Up to this point, there has been no consideration of income taxes in our discussion of engineering
economy, except for the influence of depreciation and other type of deductions. By not complicating
our studies with income tax effects, we have placed primary emphasis on basic engineering economy
principles and methodology. There, however, is a wide variety of capital investment problems in
which income taxes do affect the choice among alternatives, and after-tax studies are essential.
Interest Rate to Use in After-tax Studies
General Procedure for Making After-Tax Economic Analyses
Example 1:
An asset is expected to produce net cash inflows (net revenue) of $30,000 per year during the six-year
period, and its terminal MV is negligible. If the effective income tax is 40%, how much can a firm
afford to spend for this asset and still earn the MARR?
Example 2: After-Tax Analysis of an Integrated Circuit Production Line
Sample Computation of
depreciation
Yr 1 d= 6M * 0.200= 12M
Yr 2 d= 6M *.3200 = 19.2M
Example 3 After-Tax Analysis of Alternatives with unequal lives
Solution:
Note that the design alternatives have different lives. The same basic principles of engineering
economy apply to both before-tax and after-tax analyses. Therefore, we must analyse the two system
designs over common period of time. Annual worth method simplifies the analysis of alternatives
having different lives.
Both alternatives would be depreciated using five-year GDS recovery period. No adjustment to the
GDS rates required because the useful life of each alternative is greater than or equal to six years of
depreciation deduction. (Refer to GDS Table provided in example 2)
After-tax Analysis of Design S1
After-Tax Analysis of Design S2
INFLATION
General price inflation is an increase in the average price paid for goods and services bringing about
a reduction in the purchasing power of the monetary unit, is a business reality that can affect the
economic comparison of alternatives.
The history of price change shows that price inflation is much more common than general price
deflation, which involves a decrease in the average price for goods and services with an increase in
the purchasing power of the monetary unit.
One measure of price changes in our economy is the consumer price index (CPI). The CPI is a
composite price index that measures the average change in the prices paid for food, shelter, medical
care, transportation, apparel, and other selected good and services used by individuals, and families.
The published annual CPI end of- year values can be used to obtain an estimate of general price
inflation. This is accomplished by computing the annual change rate (%). The annual change rates
are calculated as follows:
(CPI annual change rate, %)K = (Index)k - (Index) k-1 (100%)

(Index)k-1
Example: The end of year CPI for 2006 was 201.6 and the estimated end of year CPI for
2007 is 208.1. The CPI annual change rate for 2007 is the estimated to be
CPI 2007 - CPI 2006 = 208.1-201.6 = .0317 (100%) = 3.17 %

CPI 2006 201.6
TERMINOLOGY AND BASIC CONCEPTS
1. Actual dollar or Peso (A$ or A₱) – number of dollars or pesos associated with a cash flow as of
the time it occurs.
2. Real dollar or peso R$ or R₱ – Money expressed in terms of the same purchasing power
relative to a particular time.
3. General price inflation rate (f ) – a measure of the average change in the purchasing power of
money during a specified period of time.
4. Market (nominal) interest rate ( im ) – The money paid for the use of capital, normally expressed as
an annual rate that include a market adjustment.
5. Real interest rate (ir) - The money paid for the use of capital, normally expressed as an annual rate
that does not include a market adjustment.
6. Base time period (b) – The reference or base time period.
Relationship of Actual Dollars (or Pesos) and Real Dollars (or Pesos)
The relationship between actual dollars/pesos and real dollars or pesos is defined in terms of the general price
inflation rate, that is a function of f
Example: An engineering project team is analysing the potential expansion of an existing production facility.
Different design alternatives are being considered. The estimated after-tax cash flow (ATCF) in actual dollars
for one alternative is shown in column 2 of Table 1. If the general price inflation rate ( f ) is estimated to be
5.2% per year during the eight-year analysis period, what is the real-dollar ATCF that is equivalent to the
actual-dollar ATCF? The base time period is year zero (b=0).
Solution:
The application of equation (8-1) is shown in column 3 of Table 1. The AFCF in real dollars shown in
column 4 has purchasing power in each year equivalent to the original ATCF in actual dollars (column 2).
Table 1 ATCFs for Example
The relationship among im, ir , and f

Equation (8-1) showed the relationship between an actual-dollar amount and the real dollar amount of equal
purchasing power in period k is a function of the general inflation rate (f ). It is desirable to do engineering
economy studies in terms of either actual dollars or real dollars. Thus the relationship between the two dollar
domains is important, as well as, the relationship among im, ir , and f, so that the equivalent worth of a cash
flow is equal in the base time period when either an actual or real dollar analysis is used. The relationship
among these factors is
Similarly, based on Equation (8-5), the internal rate of return (IRR) of a real cash flow is related to the IRR
of an actual-dollar cash flow as follows: IRR r = (IRRm- f ) / (1+ f ).
Example 1
Example 2
Your salary was projected to increase at the rate of 4% per year and general price inflation was expected to be
6% per year. Your resulting estimated salary for the four years in actual and real dollars was as follows:
Work on the following problems and write your complete solution of your work in a short bond paper
with heading Assignment M6
1. A firm must decide between two silicon layer chip designs from Intel. Their effective income tax
rate is 40%, and Straight Line depreciation method is used. If the desired after-tax return on
investment is 10% per year, which design should be chosen? State your assumptions.
Design A Design B
Capital Investment $1,000,000 $2,000,000
Salvage Value at end of life $1,000,000 $1,100,000
Annual revenue less expenses $200,000 $400,000
Useful Life 7years 6 years
2. A start-up biotech company is considering making an investment of $100,000 in a new filtration

system. The associated estimates are summarized below:
Annual receipts $75,000
Annual expenses $45,000
Useful life 8 years
Salvage value $20,000
Straight line depreciation will be used, and the effective income tax rate is 20%. The After-tax
MARR is 15% per year. Determine whether this investment is an attractive option for the company.
3. Two alternatives, A and B, are under consideration. Both have a life of five years. Alternative A
needs an initial investment of $17,000 and provides a net revenue of $4,000 per year for five
years. Alternative B requires an investment of $19,000 and has an annual net revenue of
$5,000. All estimates are in actual dollars. Inflation is expected to be 2% per year for the next
five years, and the inflation-free (real) MARR is 9.8% per year. Which alternative should be
chosen?
End of Module 6
MODULE 7
DECISIONS UNDER CERTAINTY- Replacement Analysis

 TLO 7: To solve problems on determining whether a currently owned asset should be kept in
service or immediately replaced.
New Flood Control Pumps
After Hurricane Katrina there was a need to replace outdated

hydraulic flood control pumps in New Orleans. These old pumps
are powered by pressurized oil and they can be replaced by a
newer and more expensive type of pump that utilizes an up-to-
date drive design having solid drive shafts instead of
pressurized oil.
Should the shafts by replaced? _____________
Based on the problem above, what would you consider as your factors for replacing an
existing asset? Write your answers in the space provided below. Submit your work in the
Google Classroom under classwork Engage M5.3
Replacement Studies
Replacement analysis focuses on situations in which aging equipment will be replaced by new or newer
equipment. The aging equipment may be sold, donated to charity, dismantled for parts, or shifted to another
use.
Reasons that an equipment may be replaced include:
 Reduce performance – old equipment is often less productive or efficient

 Altered requirements for using the equipment- conditions of use have changed.
 Obsolescence due to a new, improved model.
 The risk of catastrophic failure or unplanned replacement.
 Shifts between renting or leasing and owning
Factors to be considered for existing equipment:
1. Remaining Life
In these comparisons, the remaining life of the existing asset is almost always shorter than the life of
the potential new equipment. The existing asset is usually nearing the end of its life, since its performance is
decreasing, it is becoming obsolete, or requirements are changing. The new equipment is at the beginning of
its life. Since the lives of the old and the new are different, the normal method of comparison are ROR on
additional investment method and Annual Cost (AC) Method.
2. Market Value/ Trade-in Value
The correct value of equipment is its market value. This is what would be received if the old or
existing asset were sold and replaced. Sunk costs are incurred when a property is sold less than its book value
(Sunk cost= book value – market value). Sunk costs are irrelevant in replacement analysis.
Steps in replacement analysis:
Step 1. Determine investment cost of new asset and the market value or trade-in value of the existing
asset.
Step 2. Compute for the annual expenses incurred for new asset and existing asset. For the existing
asset, the depreciation expense should be recomputed using market value and remaining life.
Step 3. Apply either ROR on additional investment method or annual costs method.
Example 1: A recapping plant is planning to acquire a new Diesel generating set to replace its present unit
which they run during brownouts. The new set would cost P135,000 with a 5-year life and no estimate
salvage value. Variable operating cost would be P150,000 a year. The present generating set has a book value
of P75,000 and remaining life of 5 years. Its disposal value now is P7,500, but it would be zero after 5 years.
Variable operating cost would be P187,500 a year. Money is worth 10% Which is more profitable, to buy the
new generator set or retain the present generator set?
Given: Old New
Market Value 7,500 Investment 135,000
Operating Cost 187,500 150,000
Remaining Life 5 years Life 5 years
Solution: Using ROR on additional investment method

OLD NEW
Market Value ₱7,500 Investment ₱135,000
Annual Expense
Variable cost ₱187,500 ₱150,000
Depreciation
(7,500−0)
( 1.100.10−1 )
5 ₱1,228.48 (135,000−0)
( 1.100.10 )
5 −1 ₱22,112.66
Total Annual Expense ₱188,728.48 ₱172,112.66
₱ 188,728.48−172,112.66
ROR on additional investment on new gen. set = * 100%
₱ 135,000−7,500
= 13.03% > 10%
(Note: For the old generator set, in the computation of the depreciation the market value and
remaining life is considered in the sinking fund formula method.)
Decision: Buy the new generator set because the rate of return on the additional investment in
buying the new set of 13.03% is greater than 10%.
Solution: Using Annual Cost (AC) Method
OLD NEW
Variable cost ₱187,500 ₱150,000
Depreciation ₱1,228.48 ₱22,112.66
Interest on Investment ₱750 ₱13,500
(0.10 * 7,500) (0.10 * 135,000)
Total Annual Expense ₱189,478.48 > ₱185,612.66
Decision: Buy the new generator set because the total annual cost is lesser than the total annual cost if
the old generator set is used.
Work on the following exercise using the two methods presented here in this module. This is an
opportunity for you to practice your knowledge and skills you acquired in this unit. Final answers are
provided at the end of each problem to serve as your guide. Write your complete solution in a short
bond paper under the heading Assignment 7
1. It is desired to determine the present economic value of an old machine by considering of how it
compares with the best modern machine that could replace it. The old machine is expected to require
out-of-pocket costs of ₱85,000 each year for 4 years and then be scrapped for ₱5,000 residual value.
The new machine requires an investment of ₱40,000 and would have out-of-pocket costs of ₱79,000
a year for 8 years and then zero salvage value. Invested capital should earn a minimum return of 15%
before taxes. Determine the present value of the old machine.
Ans: ₱11,200
2. A company that sells computers has proposed to a small public utility company that it purchased a
small electronic computer for P1,000,000 to replace ten calculating machines and their operators. An
annual service maintenance contract for the computer will be provided at a cost of P100,000 per year.
One operator will be required at a salary of P96,000 per year and one programmer at a salary of
P144,000 per year. The estimated economical life of the computer is 10 years.
The calculating machine cost P7,000 each when new, 5 years ago, and presently can be sold for
P2,000 each. They have an estimated life of 8 years and an expected ultimate trade-in value of P1,000
each. Each calculating machine operator receives P84,000 per year. Fringe benefits for all labor cost
is 8% of annual salary. Annual maintenance costs on the calculating machines have been P500 each.
Taxes and insurance on all equipment is 2% of the first cost per year
If capital costs the company about 25%, would you recommend the computer installation? Ans.
Calculating Machines should be replaced.
End of Unit 7
MODULE 8
Evaluating Projects with the Benefit-Cost Ratio Method

 TLO 8: Demonstrate the use of the benefit-cost ratio for the evaluation of public projects
Constructing a Bypass to Relieve Traffic Congestion
Two heavily travelled highways currently intersect in the middle of a major metropolitan area. A
25-mile, four-lane by-pass is being considered to connect the busy highways at a point outside of
the metropolitan area. The projected construction cost of the bypass is $20 million. Annual
maintenance of the roadway is expected to be $500,000, Major monetary benefits of reduced time
delay due to traffic congestion, improved traveller safety, and expand opportunities for
commercial businesses are anticipated to be around $2 million per year.
This bypass would be government owned and maintained and is therefore considered a public
project. This topic you will learn how public projects such as this are evaluated using a benefit-
cost ratio.
Public Sector Engineering Economy/ benefit Costs Ratio

Government agencies must decide which projects should be supported with available funds- in spite of
politics, competing objectives, and benefits that are difficult to quantify. The solution is to accept that the
answers may be less accurate than those in the private sector and to use benefit/cost methodology correctly.
Definition of terms:
 Benefits – are positive outcomes or consequences to the public at large.

 Disbenefits – are negative outcomes or consequences to the public at large.
 Costs – are consequences to the government. (ex: construction costs and expenses
Example of identifying benefit, disbenefits, and costs for public projects:
Other Examples of Benefits and Disbenefits for Public Projects:

Projects Benefits Disbenefits
Bridge across river in middle of Long-term increase in traffic Businesses and homes displaced,
city capacity and reduce congestion short-term congestion due to
construction
Less reliance on coal so less air Short and long-term

Nuclear Power Plant pollution and less CO2 environmental risks
Increase quality of Life, increased

tourism Businesses and homes displaced,
City Museum or performing arts loss of business for competing
center entertainment option
Difficulties in Evaluating Public-Sector Projects:

1. There is no profit standard to be used as a measure of financial effectiveness. Most public
projects are intended to be non-profit.
2. The monetary impact of many of the benefits of public projects is difficult to quantify.
3. There may be little or no connection between the project and the public, which is the owner of the
project.
4. There is often strong political influence whenever public funds are used. When decisions
5. Public projects are usually much more subject to legal restrictions than are private projects. For
example, the area of operation for a municipally owned power company may be restricted such
that power can be sold only within the city limits, regardless of whether a market for any excess
capacity exists outside the city.
6. The ability of governmental bodies to obtain capital is much more restricted than that of private
enterprises.
7. The appropriate interest rate for discounting the benefits and costs of public projects is often
controversially and politically sensitive.
B/C = (Benefits – Disbenefits) / Costs

Net Annual Profit or Savings =
Annual Income – Annual Expenses
Criterion: If the computed B/C ratio is greater than or equal
to one then the project is justified.
Example: The Department of Public Works and Highways (DPWH) is considering the construction of a new
highway through scenic rural area. The road is expected to cost P50 million with annual upkeep estimated at
P400,000. The improved accessibility is expected to result in additional income from tourists of 7 million per
year. The road is expected to have a useful life of 25 years. If the rate of interest is 15%, should the road be
constructed?
Solution:
 Initial Cost of Road = 50 million
 Annual Upkeep of Road = P400,000
 Benefit (Income from Tourist) = 7 million
 Life in year = 25 years
 Interest rate i = 15%/year
Solution:
1st step draw cashflow diagram of benefit and costs separately
Income from tourist = P 7 million
0 1 2 3 24 25 yrs
Benefits
0 1 2 3 24 25 yrs
Costs
Upkeep =A= 400,000/yr

50 M
Using AW method:
AW Benefit = P 7 million
AW Costs = 50 million
[ .15
1−( 1+ 0.15 )−25 ]
+ 400,000 = P8,134,970.116
P 7 million
B - C = ----------------------------------------------------- = .86
P 7,988073.52
B – C = .86 < 1
Since the B-C ratio is less than 1 therefore the road should not be constructed.
Using PW method:
[ ]
−25
1−( 1+ 0.15 )
PW Benefit = P 7 million = P45,249,043.6
0.15
[ ]
−25
1−( 1+ 0.15 )
PW Costs = 50 million + 400,000 = P52,585,659.63
0.15
P45,249,043.6
B - C = ----------------------------------------------------- = .86
P52,585,659.63
B – C = .86 < 1
Since the B-C ratio is less than 1 therefore the road should not be constructed.
Comparison of Mutually Exclusive Projects by B-C Ratios
Incremental B-C ratio Procedure

(MEA – Mutually Exclusive Alternatives)
Submit your work in our Google Classroom under Classwork Assignment M8
1. Determine the B/C ratio for the following project.
Ans: B/C = 1.16

2. Data for two alternatives are as follows:
Using an interest rate of 20%, which alternative should be chosen?

Ans: Alternative A is referred over Alternative B
Work on the following problems and submit your work in our Google Classroom under Classwork
Quiz Assignment M8
1. A new water treatment plant proposed for Anytown, has an initial cost of P56 million. The new plant
will service the 7,500 residential customers for the next 30 years. It is expected to save each customer
P125 per year. The plant will require a major overhaul every 5 years, costing P1million. Determine the
benefit/cost ratio at the city’s interest rate of 6%. Use PW and EUAC.
2. There is five alternatives for improvement of a road. Determine which alternative should be chosen if
the highway department is willing to invest money as long as there is a B/C ratio of at least 1.00.
Ans: Alternative E is referred.
End of Module 8
MODULE 9
Breakeven and Sensitivity Analysis

 TLO 9: To illustrate breakeven and sensitivity methods for investigating variability in outcomes
of engineering projects.
Renting Vs. Purchasing a Home
A common situation faced by young families is whether to rent or to buy

a home. Many of the decision factors are speculative, such as future resale
value of the house and how long the family will be in particular area. For
example, what will be the resale value of a home currently valued at
$150,000 five years from now? If you plan to stay in your current location
for only three years, should you rent or purchase a home?
Breakeven Analysis for Alternative Methods.
Many situations are encountered where the cost of two or more alternatives may be affected by a common
variable. Breakeven point is the value of the variable for which the costs for the alternatives will be equal.
The common variable could be units produced, hours work, etc.
Breakeven Chart: is a graphical representation of breakeven analysis. The breakeven point is the quantity of
production at which the total cost line for each alternative intersects.
*Methods commonly used to solve for breakeven are Annual Costs method and ROR on additional
investment method.
For Annual cost method, to solve for the breakeven variable, the Total Annual Cost of the two
alternative are equal.
For Rate of Return Method, the ROR on additional investment of the two alternatives must be
equal to be able to solve for the breakeven point in units.
Example 1: A manufacturing company has a choice between 2 machines to produce a certain product.
Relevant data are as follows:
MACHINE A MACHINE B
First Cost ₱20,000 ₱28,000
Salvage Value ₱2,000 0
Life, years 10 6
Annual Operating Cost ₱3,000 + ₱5/unit ₱2,000 + ₱15/unit
If money is worth 7%, what annual production is required to justify purchase of machine B?
Solution using Rate of Return Method or (ROR)

Let x = annual production
Annual Expense : A B
Operating Cost 3,000 +5x 2,000+ 1.5x
Depreciation
(20,000−2000)
( 0.07
1.07 10−1 )
= 1,302.80 (28,000−0)
( 0.07
1.07 6−1 )
= 3,914.28
-----------------------------------------------------------------------------------------------------
Total Annual Expense P 4,302.80 +5x P5,914.28 +1.5x
To breakeven the ROR on additional investment must be equal to the interest on investments.
(4,302.80+5x ) – (5,914.28 + 1.5x)
0.07 = --------------------------------------------------
28,000 – 20,000
X = 620.42 units answer
Solution using Annual Cost Method (AC)

Let x = annual production
For Annual Costs : A B
Operating Cost 3,000 +5x 2,000+ 1.5x
Depreciation:
(20,00−2000)
( 0.07
10
1.07 −1 )
= 1,302.80 (28,000−0)
( 0.07
6
1.07 −1 )
= 3,914.28
Interest on Investment:
(0.07) (P20,000) = 1,400 (0.07)(P28,000)= 1,960
----------------------------------------------------------------------------------------------------------
Total Annual Costs (TAC) 5,702.80 +5x 7874.28 +1.5x
To breakeven the TAC of the alternatives must be equal
TAC A = TAC B
5,702.80 +5x = 7874.28 +1.5x
X = 620.42 units answer
Conclusion: Based on the given, Machine B is more expensive and has shorter life than Machine A,
therefore, to justify the purchase of Machine B, the company should produce at least 620 units per year.
Producing less than this value means the company has no choice but to choose Machine A.
Using graphical method:

From the Total Annual Costs (TAC) equation of alternatives A and B, assume values of x or the annual
production and substitute in the equations to determine the values of y or total annual costs. Since the
equations are linear, two coordinates from each equations are needed to construct the line.
TACA = y = 5,702.80 +5x TACB= y = 7874.28 +1.5x
If x = 0 y = 5,702.80 if x = 0 y = 7874.28
x = 1000 y = 10,702.80 x = 1000 y = 9,874.28
Plot the points in a graph with x-axis representing annual production while the y-axis represents the Total
Annual Costs. The breakeven point(BEP) is the intersection
TAC A Line
P10,000 TAC B Line
BEP
Total Annual Costs (y)

units P5,000
BEP = 620
0 500 1,000
0
Annual Production (x)

units
Conclusion: Based on the graph, the intersection is the breakeven point or BEP where the Total
Annual cost of A (TACA) is equal to the Total Annual Cost of B (TAC B). By drawing the
vertical line from this point towards the x-axis, the value of the breakeven point (BEP) can be
identified, meaning this is the annual production where the company can choose either
Alternative A or Alternative B. Producing more than this BEP would mean Alternative B
would always have the lowest TAC and should be chosen while producing less than the BEP
would mean that Alternative A would always have the lesser TAC and therefore should be
chosen.
Breakeven for Business Enterprise

Breakeven point is the quantity of production at which the income is equal to total costs. It is the level
of production where there is no profit and no loss.
Example 2: A small shop in Bulacan fabricates portable threshers for the palay producers in the locality. The
shop can product each thresher at a labor cost of P1800. The cost of material for each unit is P2,500. The
variable costs amount to P650 per unit, while fixed charges incurred per annum totals P69,000. If the portable
threshers as sold at P7,800 per unit, how many units must be produced and sold per annum to break-even?
Support your answers with computations and also by graphical solution.
Solution:
Given: VC/ unit = P1,800 + 2,500 + 650 = P4,850 per unit
SP/ units = P7800 per unit
TFC (Total Fixed costs) = P69,000 per year
Required: BEP in pesos and units
Solution: BEP = TFC = 69,000 = 24.21 or 25 units

SP – VC 7800-4850
BEP (Pesos) = 25 x P7,800 = P195,000

Conclusion: The breakeven point of the shop is about 25 units of threshers, meaning, if the shop will
only 25 units of threshers, there will be no profit and no losses. The shop should produce and sell more
than the breakeven point in order to gain profit. If the shop will produces and sells at less than 25 units
then the shop will incur losses.
Graphical Solution:
Using the equation of annual income and total annual costs, assume values of x or the annual production and
substitute in the equations to determine the values of y. Since the equations are linear, two coordinates from
each equations are needed to construct the line.
Annual income = SP x Total Annual costs = VCx + TFC
y = 7,800 x y = 4950x + 69,000
If x = 0 y= 0 if x = 0 y = 69,000
x = 50 y = 390,000 x = 50 y = 316,500
Then plot the points on the x-axis and y-axis, respectively, then connect the points to generate the income line
and total cost line as shown in the graph.
Total Annual Costs (y)
and Annual Income (y)
400,000 Income Line
Total Cost Line

Profit
200,000
Loss
BEP = 25 units
0 50
25
Annual Production in units (x)

units
Based on the results of the graph, the breakeven point is the point of intersection of the Income Line and Total
Costs Line because it is the point where the Income is equal to Total Costs therefore there is no profit and no loss.
Drawing a vertical line from this point gives the BEP(x) or breakeven point in units while drawing a horizontal
line from this point gives the BEP(P) or breakeven point in pesos. If the shop sells less than 25 units of threshers,
the shop will incur losses because Income Line is less than the total cost line. But if the shop sells more than 25
units, the shop will earn profit because the income line is greater than the total cost line.
Sensitivity Analysis
- Sensitivity is used to explore what happens to a project’s profitability when the estimated value of study factors
are changes. For example, if annual expenses turn out to be 10% higher than expected, will the project still be
acceptable?
- Sometimes, sensitivity is specifically defined to mean the percentage change in one or more factors that will
reverse a decision among project alternatives or reverse a decision about the economic acceptability of a single
project. This percent change is called sensitivity with respect to reversal points
Example: Consider a proposal to enhance the vision system used by a postal service to sort mail. The new system is
estimated to cost $ 1.1 million and will incur an additional $200,000 per year in maintenance costs. The system will
produce annual savings of $500,000 each year (primarily by decreasing the percentage of misdirected mail and reducing
the amount of mail that must be sorted manually). The MARR is 10 per year, and the study period is five years at which
time the system will be technologically obsolete (worthless). The PW of this proposal is
Determine how sensitive the decision to invest in the system is to the estimates of investment cost and annual savings.
Solution:
Spiderplot- an approach that makes explicit the impact of variability in the
estimates of each factor of concern on the economic measure of merit. The example below demonstrates this
technique by plotting the results of changes in the estimates of several factors, separately, on the PW of an
engineering project.
Work on the following problems and write your complete solution in a short bond paper with title of
Assignment M9
1. Data for two 50-h motors are follows:
Power cost is 2.00 per kWh. If money is worth 20%, how many hours per year would the motors have
to be operated at full load for them to be equally economical? If the expected number of hours of
operation per year exceeds the break-even point, which motor is more economical? (Use ROR and
AC and draw the breakeven chart)
2. A local company assembling stereo radio cassette produces 300 units per month at a cost of 800 per
unit. Each stereo radio cassette sells for 1,200. If the firm makes a profit of 10% on its 10,000 shares
with a par value of P 200 per share, and the fixed costs are 20,000 per month.
(a) What is the break-even point? Draw Breakeven Chart
(b) How much is the loss or profit if only 100 units are produced in a given month?
3. A large city in the mid-West needs to acquire a street-cleaning machine to keep its roads looking nice
year round. A used cleaning vehicle will cost $85,000 and have a $20,000 salvage value at the end of
its five year life. A new system with advanced features will cost $150,000 and have $40,000 market
value at the end of its five year life. The new system is expected to reduce labor hours compared with
the used system. Current street-cleaning activity requires the used system to operate 8 hours per day
for 20 days per month. Labor costs $50 per hour (including fringe benefits), and MARR is 12% per
year.
a. Find the breakeven percent reduction in labor hours for the new system.
b. If the new system is expected to be able to reduce labor hours by 17% compared with the used
system, which machine should the city purchase?
c. Investigate how sensitive the decision is to 1) changes in the market value of the new system and 2)
the productivity improvement of the new system. Graph your results. Hint: Think incrementally!
End of Unit 9
MODULE 10
DECISION UNDER RISK AND UNCERTAINTY
 TLO 10: To discuss and illustrate several probabilistic methods that are useful in analyzing risks
and uncertainty associated with engineering economy studies.
Risks of Global Warming
Risks is a condition where there is a possibility of adverse deviation from a desired and expected
outcome. The risks of global climate change caused by carbon dioxide and other greenhouse gases include
heightened regulation, revenue loss, and increased physical property impairment. Opportunities for
mitigating the risks associated with climate change are numerous: increased efficiency of energy production
and use, improved agricultural practices, carbon capture and sequestration are just few of the choices we
have. In this module, you will learn how various probabilistic techniques can be used to assess risks of
engineering projects such as those that mitigate the effects of global warming.
INTRODUCTION
In the previous modules, the specific assumptions concerning applicable revenues, costs, and other quantities
important to an engineering economy analysis are stated. It was assumed that a high degree of confidence
could be placed in all estimated values. Decisions made solely on the basis of this kind of analysis are
sometimes called decisions under certainty.
Consider the more realistic situation in which estimated future quantities are uncertain and project outcomes
are risky. Both risk and uncertainty in decision making activities are caused by lack of precise knowledge
regarding future business conditions.
Decisions under risk - are decisions in which the analyst models the decision problem in terms of assumed
possible future outcomes, or scenarios, whose probability of occurrence can be estimated
Decision under uncertainty – is a decision problem characterized by several unknown futures for which
probabilities of occurrence cannot be estimated.
Decision Making Under Risk

Choosing alternatives Using Expected Values
The mathematical expectation or the expected value of a random variable X, is the average value or the mean
of the probability distribution of X, and is usually referred to as μ∨E ( x ) . The mean or expected value is
calculated as:
E ( x )=∑ xf ( x ) if x isdiscrete
x
+∞
)=∫ xfdata”,
Discrete random variables often referEto( x“count ( x ) dxorifvariables
x is continuous
whose outcomes are countable, such as the
number of heads in 10 coin tosses, number of −∞Covid-19 cases in a given day, number of codes opened for a
course, number of students present, etc.

Continuous random variables often refer to “measured data”, or variables whose outcomes can be measured
such as lengths, widths, heights, diameters, weights, volumes, temperatures, etc.
CHOOSING ALTERNATIVES USING EXPECTED VALUES

The best choice among alternatives has the maximum expected worth or the minimum expected cost. We
calculate each alternative’s expected PW and choose the largest. Or, we calculate the expected EAC
(Expected Annual Cost) for each alternative and choose the lowest.
Example 1. New Product Development
The
solution applied makes use of the Present Worth (PW) method.
The expected first cost is the mean or average of the three possible first costs using the formula for
mathematical expectation (discrete),
E first cost =∑ First Cost∗probability of each first cost

The expected PW (present worth) = -PW of the expected first cost + PW of the expected annual revenues.
Sincethe net PW >0 , the new product is feasible.

Reminder: costs are given a negative sign since they are considered as outflows, while revenues are given a
positive sign since they are considered as inflows.
Example 2. Flood damage protection
The
solution applied makes use of the EAC (Equivalent Annual Cost) method.
Reminder: The EAC or EUAC method converts all cash flows to a uniform annual value.
To get the EAC of each of the first costs (Column 2), multiply each first cost by the interest factor (A/P, 6%,
50).
Expected annual flood damage (Column 3) is calculated as
P(flood) for each year*damages if flood occurs.
Total expected EAC is the sum of Columns 2 and 3.
Since the alternatives are compared based on equivalent annual costs, the alternative that gives the lowest
EAC will be chosen (4m levee height).
Economic Decision Trees

Engineering economy problems often involve sequences of decisions that may be intermixed with chance
occurrences. Rather than using tables, we use economic decision trees to describe the problem’s structure.
Each node of the tree represents a decision point or a chance occurrence. The branches that radiate from a
decision node are the alternatives, and the branches that radiate from a chance node are the states of nature.
A simple example is shown in example 3 for insuring a car against collision damage.
The owner of the car needs to choose between buying insurance worth $300 or just self-insuring for property
damage. After the decision has been made, then there are chance nodes for the different severities of an
accident (if any). Each branch from a chance node has a probability between 0 and 1. The probabilities for the
branches from a chance node sum to 1, since some outcome must occur (one chance branch must be selected).
Decision trees are used in a two-stage process. In the first stage, their construction graphically
organizes and structures the problem, as shown in the next page. Starting with the chance occurrence or the
decision that occurs first, nodes and branches are added until the problem is completely described. At the
same time, probabilities are entered on the chance branches, and any cash flows are entered on both the
chance and alternative branches.
To summarize the data for the problem, the following cost table (from the point of view of the car owner) has
been developed:
States of nature
Alternatives No accident Small accident Total accident
Buy insurance $0 $300 $500
Self-insurance $0 $300 $9000
Probability 0.90 0.08 0.02
The decision tree for the auto insurance problem looks like this:
Total EAC for Alternative A (Buy Insurance) = 0+24+10=$34 + $300 (cost of insurance) = $334
Total EAC for Alternative B (Self-Insure)= 0+24+180= $204
The formula for expected value (or mathematical expectation) was used in computing the EAC for each
alternative.
E ( x )=∑ xf ( x )
x
In terms of economics, Alternative B (self-insurance) has a lower EAC, so it is more economical to self-
insure rather than buy an auto insurance. However, if the car is financed through a loan, the owner will still be
required to purchase an auto insurance.
Work on the following problem exercises

Annual savings in labor costs due to an automation project have a most likely value of $35,000. The
high estimate of $45,000 has a probability of .1, and the low estimate of $30,000 has a probability of .2. What
is the probability distribution and the expected value for the annual savings? (Answer: $35K)
1. MoreTech uses a discount rate of 15% to evaluate engineering projects. Should the following
project be undertaken if its life is 10 years and it has no salvage value?
Work on the following problems and submit your work in our Google Classroom under Classwork
Assignment 10
1. A new snow-making machine utilizes technology that permits snow to be produced in ambient
temperature of 70 ℉ or below. The estimated cash flows for the ski resort contemplating this
investment are uncertain as shown below:
Amount ($) Probability

Capital investment 120,000 1.00
140,000 0.60
Annual revenues
135,000 0.40
60,000 0.60
Annual expenses
50,000 0.40
40,000 0.50
Salvage value
35,000 0.50
The machine is expected to have a useful life of 12 years, and the MARR of the ski resort is 8% per
year. Is it worth investing in this resort? (Use PW method)
2. NewTech wants to consider risk and return in evaluating the following alternatives:
a. Draw the decision tree for the problem.

b. Which will you select based on the expected value of each alternative’s PW?
End of Module 10
ACTIVITIES
GENERAL INSTRUCTIONS: For all the problems, provide the given, required and complete logical
solutions. Include cash flow diagrams as needed. Write your answers on a clean sheet of bond paper. Box
your final answers in two decimal places. Homework have a total points of 30, 50 for quizzes, and 100 for
exams.
PRELIM ACTIVITIES
Module 1 Homework Answer Page 26- Evaluative Module 1- Unit 2 Evaluative Assessment
Classwork.
Module 2 Homework
Answer Page 38- Evaluative Module 2- Unit 1 Evaluative Assessment Classwork.
Answer Page 50- Evaluative Module 2- Unit 2 Evaluative Assessment Classwork.
Answer Page 60- Evaluative Quiz Assignment
MIDTERM ACTIVITIES
Module 3 Homework
Answer Page 72- Evaluative Module 3 Evaluative Assessment Classwork.
Module 4 Homework
Answer Page 85- Evaluative Quiz Assignment M4
Module 5 Homework 2
FINALS ACITIVITIES
Module 6 Homework.
Answer Page 108 - Evaluative Module 6 Evaluative Assessment Classwork.
Module 7 Homework.
Answer Page 113 - Evaluative Module 7 Evaluative Assessment Classwork.
Module 8 Homework.
Answer Page 123- Evaluative Module Quiz Assessment M8
Module 9 Homework.
Answer Page 134-135 - Evaluative Module 9 Evaluative Assessment Classwork.
Module 10 Homework.
Answer Page 142-143 - Evaluative Module 10 Evaluative Assessment Classwork.
EXAMS

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COURSE GUIDE IN

SCHOOL OF ENGINEERING AND ARCHITECTURE

Write your answers in the space provided

Definition of Engineering Economy

Principles of Engineering Economy

 The foundation of engineering economy is defined to be a set of principles that provide a

Principle 1: Develop the alternatives

Principle 2: Focus on the differences

Principle 3: Use a consistent Viewpoint

Principle 4 Use a common unit of measure

Principle 5 Consider all relevant criteria

Principle 6 Make Risk and Uncertainty Explicit

Principle 7 Revisit your Decisions

Engineering Economy and the Design Process

 An engineering economy study is accomplished by using a structured procedure and

1. Define Problem: Key problem characteristics include but not limited to

3. Identify Alternatives: If the pump will be purchased from a catalog or

4. Evaluate Consequences: Charlene must enumerate each alternative’s

5. Select: Charlene must select a pump based on costs and benefits

6. Implement. The pump must be ordered and installed.

4. Evaluate Consequence: A common mistake when evaluating alternatives is short

6. Implement: The selection process may determine the success or failure of

Ethics and Decision Making

 Business and personal decision making is guided by ethics.

Engineers, in the fulfilment of their professional duties, shall:

 Perform services only in areas of their competence.

 Issue public statements only in an objective and truthful manner.

 Act for each employer or client as faithful agents or trustees

 Avoid deceptive acts.

 Conduct themselves honorably, responsibly, ethically, and lawfully so as to enhance the

Self Assessment 1: Application of the Engineering Economic Analysis Procedure.

____ Raw Material ______ Administrative Salaries

____ Direct Labor ______ Payroll Taxes

____ Depreciation ______ Insurance of building

____Supplies ______ Clerical salaries

____ Utilities ______ Sales commission

___ Property Tax ______ Rent

Classification of costs based on behavior helps in cost-volume-profit analysis. Classification based

Cost Classification Diagram

 Breakup of Product Costs

DIRECT COSTS VS INDIRECT COSTS

PRIME COSTS VS CONVERSION COSTS

FIXED COSTS VS VARIABLE COSTS

SUNK COSTS VS OPPORTUNITY COSTS

CONSUMER AND PRODUCER GOODS AND SERVICES

PRICE and DEMAND

The following diagram shows relationship of business with various parties

THE ACCOUNTING EQUATION

Assets = Liabilities + Owner’s Equity

Assets – (economic resources) examples are cash, land, building, furniture

Liabilities – (outsider claims) financial obligations to outsiders called the

Ex2: Mr. Lee paid the salary of helper.

Ex3: Mr Lee sold goods on account.

Transactions affect a business’s assets, liabilities, and owner’s equity.

Transaction 2 (T2): Mr. Lee borrowed P100,000 from the bank.

Expanded Accounting Equation

Assets = Liabilities + (Beginning Owner’s Equity + revenue –expenses)

Assets = Liabilities + Owner’s Equity

Assets = Liabilities + Owner’s Equity

Transaction Asset Liabilities Owner’s Equity

Raw Material __ Administrative Salaries

Direct Labor __ Payroll Taxes

Depreciation __ Insurance of building

Supplies __ Clerical salaries

Utilities __ Sales commission

_ Property Tax ____ Rent