Introduction

Engineering Economy
 What is it, and why is it important?
Engineering, without economy, makes no sense at all.
Economics
 One of the social sciences which consists of that body knowledge
dealing with people and their assets or resources.
 Also been defined as the sum total of knowledge which treats of the
creation and utilization of goods and services for the satisfaction of
human wants.
Engineering Economy
 Branch of Economics which involves the application of definite laws
of Economics, theories of investment and business practices to
engineering problems involving cost.
 May also be considered to mean the study of economic problems with
the concept of obtaining the maximum benefits at the least cost.
 Also involves the study of cost features and other financial data and
their applications in the field of engineering as bases for decision.
Principles of Engineering Economy
Principle 1 – Develop the alternatives:
 The choice (decision) is among alternatives. The
alternatives need to be identified and then defined for
subsequent analysis.
Principle 2 – Focus in the differences:
 Only the differences in expected future outcomes among
the alternatives are 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 other, should be consistently developed from a
defined viewpoint (perspective).
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 and comparison of the alternatives.
Principle 5 – Consider all relevant criteria:
 Selection of a preferred alternative (decision making)
requires the use of a criterion (or several criteria). The
decision process should consider both the outcomes
enumerated in the monetary unit and those expressed in
some other unit of measurement or made explicit in a
descriptive manner.
Principle 6 – Make uncertainty explicit:
 Uncertainty is inherent in projecting (or estimating) the
future outcomes of the alternatives and should be
recognized in their analysis and comparison.
Principle 7 – Revisit your decisions:
 Improved decision making results from an adaptive
process; to the extent practicable, 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 using a structured
procedure and mathematical modeling techniques. The economic
results are then used in a decision situation that involves two or more
alternatives and normally includes other engineering knowledge and
input.
 Engineering Economic Analysis Procedure (Step)
1. Problem recognition, definition, and evaluation.
2. Development of the feasible alternatives.
 3. Development of the outcomes and cash flows for each alternative.
4. Selection of a criterion (or criteria).
5. Analysis and comparison of the alternatives.
6. Selection of the preferred alternative.
7. Performance monitoring and post – evaluation of results.
 Engineering Design Process (Activity)

Cost Concepts for Decision Making

Cost estimating
 frequently used to describe the process by which the present and
future cost consequences of engineering design are forecast.
Fixed cost
 are those unaffected by changes in activity level over a feasible
range of operations for the capacity or capability available
ex.
Insurance and taxes on facilities, general management and
administrative salaries, license fees, and interest costs on borrowed
capital.

Variable cost
 are those associated with an operation that vary in total with the
quantity of output or other measures of activity level.
ex.
Material cost

Incremental cost (incremental revenue)

  is the additional cost (or revenue) that results from increasing the
output of a system by one (or more) units.
Recurring costs
 are those that are repetitive and occur when an organization
produces similar goods or services on a continuing basis.
Nonrecurring costs
 are those which are not repetitive, even though the total
expenditure may be cumulative over a short period of time.
Direct costs
 are costs that can be reasonably measured and allocated to a
specific output or work activity.
Indirect costs
 are costs that are difficult to attribute or allocate to a specific
output or work activity.
Standard costs
 are representative costs per unit of output that are established in
advance of actual production or service delivery.
Cash cost
 a cost that involves payment of cash.
Book cost
 does not involve a cash transaction and is reflected in the
accounting system as a noncash cost.
Sunk cost
 is one that has occurred in the past and has no relevance to
estimates of future costs and revenues related to an alternative
course of action.
Opportunity cost
  is incurred because of the use of limited resources, such that the
opportunity to use those resource to monetary advantage in an
alternative use is foregone.
Life – cycle cost
 refers to a summation of all the costs, both recurring and
nonrecurring, related to a product, structure, system, or service
during its life span.
Present Economy Studies
 Present economy involves the analysis of problems for manufacturing
a product or rendering a service based on present or immediate costs.
 Present economy analysis is employed when the alternatives to be
compared will provide the same result and the length of time involved
in the study is relatively short.
 Present economy studies occur in the following situations:
1. Selection of materials
2. Selection of method to be used
3. Selection of design
4. Selection of site location for a project
5. Comparison of proficiency among workers
6. Economy of tool and equipment maintenance
7. Economy of number of workers
8. Economy in the utilization of personnel

Money – Time Relationships and Equivalence

Definitions:
Principal
 the amount of money used on which interest is charge.
Interest
 the amount of money paid for the use of money called the capital
for a certain period of time.
Rate of interest
  the amount earned by one unit of principal during a unit of time.
Simple Interest
 The interest on borrowed money is said to be simple interest if the
interest to be paid is directly proportional to the length of time the
amount or principal is borrowed.
 The formula for simple interest is:
I = Pin
where:
I = total interest earned by the principal
P = amount of the principal
i = rate of interest expressed in decimal form
n = number of interest periods
 The total number F to be repaid is equal to the sum of the principal
and the total interest and is given by the formula:
F=P+I
F = P (1 + in)
Ordinary Simple Interest
 an interest based on the exact number of one bankers year which is
equal to 12 months.
one month – 30 days
one year – 360 days
 If d is the number of days in the interest period, then,
d
I =Pi
360
Exact Interest
 an interest based on the exact number of days, 365 days for ordinary
year and 366 for leap year.
d
I =Pi ( for ordinary day )
365
d
I =Pi (for leap day )
366
Examples:
1. Determine the ordinary and exact simple interests on Php 5,000.00 for
the period from January 15 to June 20, 1993, if the rate of simple
interest is 14%.
Given:
P = Php 5,000.00
i = 14%
n = 156 days
Find:
I =?
Solution:
( 156
360 )
I =Pin=5,000 ( .14 ) =Php 303.33

I =Pin=5,000 ( .14 ) (
365 )
156
=Php 299.18

2. A man borrowed Php 2,000.00 from a bank and promise to pay the
amount for one year. He received only the amount of Php 1,920.00
after the bank collected an advance interest of Php 80.00. What was
the rate of interest that the bank collected in advance?
Given:
F = Php 2,000
P = Php 1,920
I = Php 80
n = 1 year
Find:
i =?
I 80
Solution: i= = =4.17 %
Pn 1,920(1)
3. If you borrowed Php 10,000.00 from a bank with 18% interest per
annum, what is the total amount to be repaid at the end of one year?
Given:
P = Php 10,000
i = 18%
n = 1 year
Find:
F =?
Solution:
F = P(1+in) = 10,000 (1 +.18 (1)) = Php 11,800
4. If you borrowed money from your friend with a simple interest of
12%, find the present worth of Php 50,000.00 which due at the end of
7 months.
Given:
i = 12%
F = Php 50,000
n = 7 months
Find:
P =?
 F 50000
P= = =Php 46 , 728.97
( 1+ ¿)
( )
7
Solution:
(1+ ( 0.12 ) )
12
5. A Php 4,000.00 is borrowed for 75 days at 16% per annum simple
interest. How much will be due at the end of 75 days?
Given:
P = Php 4,000
n = 75 days
i = 16%
Find:
F =?
75
Solution:
F = P(1+in) = 4,000(1+(.16)( )) = Php 4,133.33
360
Problem Set No. 1
1. Mr. Juan Dela Cruz borrowed money from a bank. He received the
amount of Php 1,340.00 and promised to pay Php 1,500.00 at the end
of 9 months. Determine the simple interest rate.
Given:
P = Php 1,340.00 Find:
i =?
F = Php 1,500.00 I =?
n = 9 months
Solution:
I = F – p = 1,500 – 1,340 = Php 160.00

F 1,500
i= = x
P(1+n)
(
1,340 1+
9
12 ) 100 ¿ 15.92 %

2. A cigarette vendor borrowed Php 2400.00 and agreed to pay Php

3,000.00 after 30 days. What is the simple interest per annum?
Given:
P = Php 2,400.00 Find:
I =?
F = Php 3,000.00 i =?
n = 30 days
Solution:
I = F – P = 3000 – 2400 = Php 600.00
 I 600
i= = x 100=300 %
Pn
2400 ( )
30
360
3. An engineer promised to pay Php 36,000.00 at the end of 90 days. He
was offered a 10% discount if he pays in 30 days. Find the rate of
simple interest.
Given:
F = Php 36,000.00 Find:
I =?
n1 = 90 days P =?
n2 = 30 days i =?
d = 10%
Solution:
n = n1 -n2 = 90 – 30 = 60 day

I = Fd = 36,000(.10) = Php 3,600.00

P = F – I = 36,000 – 3600 = Php 32,400.00
I 3600
i= = x 100=66.67 %
Pn
32400 ( )
60
360
4. If you borrow money from your friend with simple interest of 12%,
find thee present worth of Php 20,000.00 which is due at the end of
nine months.
Given:
F = Php 20,000
i = 12%
n = 9 months
Find:
P =?
F 20,000
P= = =Php 18 , 348.62
Solution:
( 1+ ¿) (1+.12( 9 ))
12

5. A bank charges 12% simple interest on a Php 3,000.00 loan. How

much will be repaid if the loan is paid back in one lump sum after
three years?
Given:
P = Php 3000.00
i = 12%
n = 3 years
Find:
I =?
Solution:
F = P (1+in) = 3000 (1 + .12(3)) = Php 4080.00
Compound Interest
 the interest earned by the principal is not paid at the end of each
interest period, but is considered as added to the principal, and
therefore will also earn interest for the succeeding periods.
 the interest earned by the principal when invested at compound
interest is much more than that earned by the same principal when
Amount owed at Interest Amount per Amount Owed at
Period the Beginning of Period End of Period
Period (1) (2) = (1) x 10% (3) = (1) + (2)
1 1,000 100 1,100
2 1,100 110 1,210
3 1,210 121 1,331
invested at simple interest for the same number of periods.
 the effect of compounding of interest can be seen in the following
table for Php 1,000.00 loaned for 3 periods at an interest rate of 10%
compounded each period:

 Using the same nomenclature as that for simple interest, the total
amount due after n periods for compound interest is given by the
formula:
n
F=P ( 1+i )
 The factor (1+i)n is called the “Single Payment Compound Amount
Factor” and is designated by SPCAF = (F/P,i%,n).
Nominal Rate of Interest
 For compound interest, the rate of interest usually quoted is nominal
rate of interest which specifies the rate of interest and the number of
interest periods per year.
 For 8% compound annually for 5 years
i = 0.08% n = 5 periods
 For 8% compounded semi-annually for 5 years
i = 0.08%/2 = 0.04 n = 5(2) = 10 periods
 For 8% compounded quarterly for 5 years
i = 0.08%/4 = 0.02 n = 5(4) = 20 periods
 For 8% compounded semi-quarterly for 5 years
 i = 0.08%/8 = 0.04 n = 5(8) = 50 periods
 For 8% compounded monthly for 5 years
i = 0.08%/12 = 0.00667 n = 5(12) = 60 periods
 For 8% compounded bi-monthly for 5 years
i = 0.08%/6 = 0.013 n = 5(6) = 30 periods
Effective Rate of Interest
 the effective rate of interest is the actual rate of interest on the
principal per one year.
 it is equal to the nominal rate if the interest is compounded annually,
but greater than the nominal rate if the number of interest periods per
year exceeds one, such as for interest compounded semi-annually,
quarterly, or monthly.
n
Effective rate of interest =(1+i) −1
Present Value

 the principal P in the formula F=P(1+i)n may be considered as the

value of the compound amount F at present, or it is the amount which
when invested now will become F after n periods. P is called the
present value of the amount F, and is given by the formula:
−n F
P=F (1+i) = n
(1+i)
 the factor (1+i)-n is called the “Single Payment Present Worth Factor”
and is designated SPPWF = (P/F, i%, n).
Examples:
1. Jules borrowed Php 50,000.00 from the bank at 25% compounded
semi-annually. What is the equivalent effective rate of interest?
Given:
i = 25%
n=2
Find:
EI =?
0.25 2
Solution:
EI = (1+i)n – 1 = ( 1 + ) – 1 x 100 = 26.56%
2
2. What is the corresponding effective interest rate of 18% compounded
semi-quarterly?
Given:
i = 18%
n=8
 Find:
EI =?
0.18 8
Solution:
EI = (1+i)n – 1 = ( 1 + ) – 1 x 100 = 19.48%
8
3. Compute the equivalent rate of 6% compounded semi-annually to a
rate compounded quarterly?
Given:
i = 6%
n=2
Find:
EI =?
0.06 2
Solution:
EI = (1+i)n – 1 = (1 + ) – 1 = 0.0609
2
i 4
= (1 + ) – 1 = 0.0609
4
i
= (1 + )4 – 1 + 1 = 0.0609 + 1
4
i
= (1 + )4 = 1.0609
4
= ¿¿
i
= 1+ =1.0149
4
i
= 1+ −1=1.0149−1
4
i
= =0.0149
4
i
= 4 x =4 (0.0149)
4
= i=0.0596 x 100=5.96 %
4. Find the present worth of a future payment of Php 300,000.00 to be
made in 5 years with an interest rate of 8% per annum?
Given:
F = Php 300,000
n = 5 years
i = 8%
Find:
P =?
F 300,000
Solution: P= n
= 5
=Php 204,174.96
( 1+i ) (1+.08)
5. Find the present worth of a future payment of Php 100,000.00 to be
made in 10 years with an interest of 12% compounded quarterly.
Given:
F = Php 100,000
 n = 10 years (4) = 40
i = 12%
Find:
P =?
F 100,000
P= n
= 40
=Php 30,655.68
Solution:
( 1+i) .12
(1+ )
4
Cash Flow Diagram
 a graphical representation of cash flows drawn on a time scale.
ex.
A loan of Php 200.00 at a simple interest of 25% will become Php
450.00 after 5 years.

Continuous Compounding
 Formula:
F
1. Present worth: P= ¿
e
¿
2. Future worth: F=P e
¿
3. Compound amount factor: e
1
4. Present worth factor:
e¿
i
5. Effective annual interest: i e =e −1

where:
P = present worth
F = future worth
 i = rate of continuous compounding
n = number of periods
ie = effective annual interest

Examples:
1. A nominal interest of 3% compounded continuously is given on the
account. What is the accumulated amount of Php 10,000.00 after 10
years?
Given:
i = 3%
P = Php 10,000
n = 10 years
Find:
F =?
¿ ( 0.03 ) 10
Solution:
F=P e =( 10,000 ) e =Php 13 , 498.59
2. Compute the effective annual interest rate which is equivalent to 5%
nominal annual interest compounded continuously.
Given:
i = 5%
Find:
ie =?
i .05
Solution:
i e =e −1=e −1 x 100=5.13 %
3. A man wishes to have Php 40,000.00 in a certain fund at the end of 8
years. How much should he invest in a fund that will pay 6%
compounded continuously?
Given:
F = Php 40,000
n = 8 years
i = 6%
Find:
P =?
F 40,000
Solution: P= = =Php 24 , 751.34
e ¿ e0.06 (8)
4. If the effective annual interest rate is 4%, compute the equivalent
nominal annual interest compounded continuously.
Given:
ie = 4%
Find:
i=?
i
Solution:
i e =e −1
i
0.04=e −100
i = 3.92%

Discount
 the difference between the future worth and its present worth.
 Rate of Discount
 the discount on one unit of principal per unit of time.
i
d=
1+i
Equivalent Rate of Interest
d
i=
1−d
Examples:
1. A price tag of Php 1,200.00 is payable in 60 days but if paid within 30
days it will have a 3% discount. Find the rate of interest.
Given:
F = Php 1,200
n = 60 – 30 = 30 days
d = 3%
Find:
I =?
P =?
i =?
Solution:
I = Fd = 1,200(0.03) = Php 36.00
P = F – I = 1,200 – 36 = Php 1,164.00

I 36
i= = x 100=37.11 %
Pn
1164( )
30
360

2. Mr. Jules Lowell borrowed money from a bank. He received from the
bank Php 1,340.00 and promised to pay Php 1,500.00 at the end of 9
months. Determine the following:
a. Simple interest rate
b. The corresponding discount rate or often referred to as the
“Bankers discount”.
Given:
P = Php 1,340
F = Php 1,500
n = 9 months
Find:
I =?
i =?
d =?
 Solution:

a. I = F - P = 1,500 – 1,340 = Php 160.00

I 160
i= = x 100=15.92 %
Pn
1340
9
12 ( )
i 0.1592
b. d= = x 100=13.73 %
1+i 1+ 0.1592

3. A bill for motorboat specifies the cost as Php 1,200.00 due at the end
of 100 days but offers a 4% discount for cash in 30 days. What is the
highest rate, simple interest at which the buyer can afford to borrow in
order to take advantage of the discount?
Given:
F = Php 1,200
n = 100 – 30 = 70 days
d = 4%
Find:
I =?
P =?
i =?
Solution:
I = Fd = 1,200(0.04) = Php 48.00
P = F – I = 1,200 – 48 = Php 1,152.00

I 48
i= = x 100=21.43 %
Pn
1152 ( )
70
360