Engineering

Economy
UNIT 2
Time and Money
Relationship
 • Identify the different types of interest and
terminologies used;
• Compute for interest, present value, future
value, and discount;
• Understand inflation and its effect;
Objective • Comprehend and familiarize the use of cash
flow diagrams;
• Comprehend the concepts of annuity; and
• Apply the concepts of annuity in evaluating
engineering decisions.
Interest and the Time
Value of Money
Money

• Medium of Exchange
• Unit of Account
• Power Over Time
 • The percentage of borrowed money that is
paid to the lender on some time basis
• Justified from a lender’s perspective in view
Interest Rate of:
• Opportunity cost
• Risk of Lending
 Simple Interest
• The total interest earned or charged is linearly
proportional to the initial amount of the loan (principal),
the interest rate and the number of interest periods for
which the principal is committed.

𝐼 = 𝑃𝑛𝑖 , where

P = principal amount lent or borrowed

n = number of interest periods (e.g. years)
i = interest rate per interest period
 Simple Interest
• The accumulated amount or future worth is equal to:

𝐹 =𝑃+𝐼
𝐹 = 𝑃 + 𝑃𝑛𝑖
𝐹 = 𝑃 (1 + 𝑛𝑖)
 Simple Interest

• Ordinary Simple Interest • Exact Simple Interest

• Computed based on 12 • Based on the exact number
months of 30 days each or of days in a year, 365 days for
360 days a year an ordinary year, while 366
days for a leap year
 Simple Interest
Determine the interest of a ₱75,000 loan borrowed from
January 1, 2018 until September 16, 2018 at rate of
interest of 15% per annum. Compute based on ordinary
and exact interests.

ORDINARY
Jan 1 – Sept 16 = 8 + (15/30) = 8.5 months
I = Pni
I = 75,000 (8.5/12) (0.15)
I = ₱7,968.75
Jan 1 – Sept 16 = 8 (30) + 15 = 255 days
I = Pni
I = 75,000 (255/360) (0.15)
I = ₱7,968.75
 Simple Interest
Determine the interest of a ₱75,000 loan borrowed from
January 1, 2018 until September 16, 2018 at rate of
interest of 15% per annum. Compute based on ordinary
and exact interests.
EXACT
Jan1-31 = 30 days
(excluding Jan1)
Feb1-28 = 28
I = Pni
Mar1-31 = 31 I = 75,000 (258/365) (0.15)
Apr1-30 = 30 I = ₱ 7,952.05
May1-31 = 31
Jun1-30 = 30
July1-31 = 31
Aug1-31 = 31
Sep1-16 = 16
 Compound Interest
• Interest charge for any interest period is
based on the remaining principal
amount plus any accumulated interest
charges up to the beginning of that
period
• Interest on top of an interest
 Compound Interest

Principal Interest
Interest
Beg. Earned Amount of End Period
Period
Period During Period

1 P Pi P+Pi= P(1+i)
2
2 P(1+i) P(1+i)(i) P(1+i)+P(1+i)(i)= P(1+i)
3 P(1+i)2 P(1+i)2 (i) P(1+i)2 +
P(1+i)2 (i) = P(1+i)3
--- --- --- --- ---
n-1 n-1 + n-1 n
n P(1+i) P(1+i)n-1 (i) P(1+i) P(1+i) (i) = P(1+i)
 Compound Interest
If a friend borrowed ₱1,000 from you at a rate of
10% compounded annually, how much would be
the future values at the end of 2nd year and 3rd
year?
 Compound Interest
Interest Earned
Interest Principal Beg.
During Period Amount of End Period
Period Period
@10%
1 1,000.00 100 1,100.00
2 1,100.00 110 1,210.00
3 1,210.00 121 1,331.00

F2 = P (1+I)n F3 = P (1+I)n
= 1,000 (1+.10)2 = 1,000 (1+.10)3
F2 = 1,210 F3 = 1,331
 Compound Interest : Nominal
• “indicative” rate per annum and the number of
interest periods in one year
𝑟
𝑖= , where
𝑚
i = rate of interest per interest period
r = nominal interest rate
m = number of compounding periods per year
• Examples:
• 12% compounded quarterly means i=3% per quarter
• 15% compounded semi-annually means i=7.5% per
semester
• 24% compounded monthly means i=2% per month
Compound Interest : Nominal
r = nominal rate of interest per year
m = number of interest periods per year
mn =number of interest periods in n years
𝑟
= rate of interest per interest period
𝑚

𝑟 𝑚𝑛
𝐹 = 𝑃 (1 + )
𝑚
 Compound Interest : Nominal
What is the future worth of ₱600 after 4
years if the interest rate is 12%
compounded quarterly?
 Compound Interest : Effective
• The actual rate of interest on the principal for
one year
• Effective is equal to nominal if compounded
annually
• Effective is greater if there are more than one
interest period in one year
 Compound Interest : Effective
₱25 invested at 10% compounded quarterly.
𝐹 = 𝑃(1 + 𝑖)𝑛
.10 4
𝐹 = 25(1 + )
4
𝐹 = 27.595

𝐼 =𝐹−𝑃
𝐼 = 27.595 − 25
𝐼 = 2.595

𝑖𝑒𝑓𝑓 = 𝐼ൗ𝑃
𝑖𝑒𝑓𝑓 = 2.595ൗ25 = 0.1038
Compound Interest : Effective

𝑟 𝑚
𝑖𝑒𝑓𝑓 = (1 + ) −1
𝑚
Continuous Compounding
• When the number of interest
periods per year increases without
limit

𝑟 𝑚𝑛
𝐹 = 𝑃 lim 1 +
𝑛→∞ 𝑚

𝐹 = 𝑃 𝑒 𝑟𝑛
Interest
• If ₱100,000 is invested at 12% compounded annually, determine how
many years it will take to double?
Interest
• Which is better for an investor, to invest at 5.5% compounded semi-
annually or 5% compounded monthly?
Discount
• The difference between what it is worth in the future and its present
worth
𝐷 =𝐹−𝑃
• Rate of Discount – discount on one unit of principal per unit of time
𝐷
𝑑=
𝐹
𝑑 = 𝑖(1 + 𝑖)−1

𝑖 = 𝑑Τ1−𝑑
𝑖 = 𝐷ൗ𝑃
Discount
Mr. Juan Santos borrowed money from ABC Bank. He received ₱1,342
and promised to repay ₱1,500 at the end of 9 months. Determine the
simple interest rate, the corresponding discount rate and equivalent
interest rate for one year.
Inflation
• The annual increases in prices which decreases the purchasing power
of money
• Cost Projection of Commodity:
𝐹𝐶 = 𝑃𝐶 (1 + 𝑓)𝑛
• Buying Power of Money:
𝑃
𝐹=
(1 + 𝑓)𝑛
Inflation
• If a steel bar costs ₱206 and prices increase at a rate of 5.5%, what
would be the equivalent price in 3 years?
Inflation
• If a resident has a budget of ₱2,500,000 today, how much would be
its worth given the economic condition of 5% in 4 years?
The Concept of
Equivalence
 • Established when there is a difference
between future payment/s and a present
sum of money
• Considers the comparison of alternative
options, or proposals, by reducing them to
Economic an equivalent basis, depending on:
• Interest rate
Equivalence • Amounts of money involved
• Timing of the affected monetary receipts and/or
expenditures
• Manner in which the interest or profit on
invested capital is paid and in which the initial
capital is recovered
 • An equation of value by setting the sum of
Economic the values on a certain comparison or focal
date
Equivalence • There is equilibrium at a chosen focal point
(inflows = outflows)
Cash Flows
Cash Flow Diagrams and Tables
A = ₱2,524
3

1
0 1 2 3 4 5

4 i = 10% p.a.

P = ₱8,000
2
Cash Flow Diagrams and Tables
i=effective rate per interest period
N=number of compounding periods (years, months, quarters)
P=present sum of money
F=future sum of money
A=annuity, a series of equal payments occurring at equal period of
times
 Rule A Cash flows cannot be added or subtracted
unless they occur at the same point in time.

Cash Flow To move a cash flow forward in time by one

Diagrams Rule B unit, multiply the magnitude of the cash flow

by (1+i), where i is the interest rate that
reflects the time value of money.
and Tables
To move a cash flow backward in time by one
Rule C unit, divide the magnitude of the cash flow by
(1+i).
 • Finding F when Given P
• (1+i)N single payment compound amount
factor
Future Value
𝐹 = 𝑃(𝐹 Τ𝑃 , 𝑖%, 𝑁)
 • Finding P when Given F
• (1+i)-N single payment present worth factor
Present Value
𝑃 = 𝐹(𝑃Τ𝐹 , 𝑖%, 𝑁)
How much money will Mr. Santos receive in
5 years, if he invests ₱250,000 today, will
add ₱300,000 in year 2 and ₱100,000 in
year 4? Interest is at 10% compounded
semi-annually.
How much balance will you return to the
bank on year 4, for a loan of ₱400,000, if
you will pay ₱100,000 in year 2? Cost of
money is 12% compounded quarterly.
A girl saved ₱50,000 in the bank today. She
withdrew ₱10,000 a year after. She then saved
₱20,000 and ₱30,000 respectively in the next
two years. She withdrew ₱15,000 to travel
abroad after a year. How much is left in the
bank if interest is at 10% compounded
annually?
Ordinary Annuity
A = uniform amounts

A A A A A A

N
0 1 2 3 4 N-1

i=interest rate per period

P = present equivalent F = future
equivalent

An ordinary annuity is where payments are made at the

end of each period.
Ordinary Annuity
• Finding present equivalent value given a series of uniform equal
receipts
• P=A ( P/A, i%, N)
• uniform series present worth factor in []

1 − (1 + 𝑖)−𝑛
𝑃=𝐴
𝑖
In the next 7 years, a little boy will be
receiving ₱5,000 every year from the mutual
fund invested by his grandfather. What should
be the initial deposit, if the interest rate was
5% compounded annually?
Ordinary Annuity
• Finding future equivalent value given a series of uniform equal
receipts
• F=A ( F/A, i%, N)
• uniform series compound amount factor in []

1+𝑖 𝑛−1
𝐹=𝐴
𝑖
Every year, a businessman allots ₱250,000 to be
deposited for a future investment. If he does this
in the next 8 years, how much would be the
equivalent value of his deposits on the 8th year if
interests were a)10% compounded annually
b)10% compounded quarterly?
Ordinary Annuity
• Finding amount A of a uniform series when given the equivalent
present value
• A=P ( A/P, i%, N)
• capital recovery factor in []

𝑖 1+𝑖 𝑛
𝐴=𝑃
1+𝑖 𝑛−1
Ordinary Annuity
• Finding amount A of a uniform series when given the equivalent
future value
• A=F ( A/F, i%, N)
• sinking fund factor in []

𝑖
𝐴=𝐹
1+𝑖 𝑛−1
Mr. Ramos availed a ₱500,000 loan in a bank at 8%
simple interest for 4 years. However, due to some
difficulties, he was not able to settle it on time. Good
enough, the manager reconsidered the extension of
the loan for another 3 years with the condition that it
will be paid in 6 semi-annual payments at an interest
rate of 10.25% per annum. How much would be the 6
semi-annual payments?
A chemical engineer wishes to set up a special
fund by making uniform semi-annual end-of-
period deposits for 20 years. The fund is to
provide ₱100,000 at the end of each of every five
years of the 20-year period. If interest is 8%
compounded semi-annually, what is the required
semi-annual deposits to be made?
Deferred Annuity
A = uniform amounts

A A A
k periods

N
0 1 2 0 1 N-1

i=interest rate per period

P = present equivalent F = future
equivalent

A deferred annuity is one where the first payment is

made several periods after the beginning.
Deferred Annuity
• Finding present equivalent value given a series of uniform equal
receipts
• P=A ( P/A, i%, N) (P/F,i%,k)
• uniform series present worth factor in []
• single payment present worth factor in ()

−𝑛
1− 1+𝑖 −𝑘
𝑃=𝐴 1+𝑖
𝑖
A businessman invested ₱500,000 in a
trust fund in anticipation of a 5-year
project starting on the year 2024. If
interest rate is 5% compounded annually,
how much should he expect for each year
of the project duration?
A lathe for a machine shop costs ₱245,000 if paid
in cash. If on installment, a buyer should place
₱40,000 down payment and 10 quarterly
installments. The first due is at the end of the first
year after purchase. If money is worth 15%
compounded quarterly, determine the quarterly
installments.
On the day his grandson was born, a man invested in a
trust fund such that the boy can receive five annual
payments of ₱100,000 for his education starting with
his 18th birthday. Interest is at the rate of 12% per
annum. Should the grandson not use it in his
education, he can withdraw the lump sum on his 25th
birthday. How much was the initial deposit of the
grandfather? How much would be the equivalent lump
sum on the 25th year?
When you take your first job, you decide to start saving right
away for your retirement. You put ₱50,000 per year into the
company’s investment plan, which averages 8% interest per
year. Five years later, you move to another job and start a new
investment plan. You never get around to merging the funds in
the two plans. If the first plan continued to earn interest at the
rate of 8% per year for 35 years after you stopped making
contributions, how much is the account worth?
Annuity Due
A = uniform amounts

A A A A A A

N
0 1 2 3 4 N-1

i=interest rate per period

P = present equivalent F = future
equivalent

An annuity due is one where the payments are made at

the beginning of the period.
Annuity Due
• Finding present equivalent value given a series of uniform equal
receipts
• P=A + A( P/A, i%, N-1)
• P=A+(1+P/A, i%, N-1)

1− 1+𝑖 −(𝑛−1)
𝑃 = 𝐴 {1 + }
𝑖
A farmer bought a tractor payable in 10 semi-annual payments payable at
the beginning of the period. If the semi-annual payment is ₱45,000 at an
interest rate of 20% compounded semi-annually, what was the original cost?
A company bought a printer for
₱30,000 payable in 12 months.
Payments are to be made at the
beginning of each month. If the rate
of interest is 10% compounded
quarterly, determine the amount of
monthly payments.
Perpetuity
A = uniform amounts

A A A A A

∞
0 1 2 3 4 N

i=interest rate per period

P = present equivalent

A perpetuity is an annuity in which payments continue

indefinitely.
Perpetuity
• P=A( P/A, i%, ∞)

1− 1+𝑖 −∞ 𝐴
𝑃=𝐴 =
𝑖 𝑖
A road project in Davao del Sur will require an annual
maintenance cost of ₱150,000. How much should be
invested now to ensure there is a regular fund for such,
if cost of money is 5%?
What amount of money invested today at 15% interest can provide the following
scholarships:
a. ₱300,000 at the end of each year for 6 years
b. ₱400,000 for the next 6 years
c. ₱500,000 thereafter
A contractor anticipated that three years after
project completion, the steel bridge would require
annual replacement on some parts. If the
government would allot ₱500,000 to be placed in
a mutual fund earning at 6% compounded
annually, how much would be available yearly?
Uniform Arithmetic Gradient (n-1)G

3G
2G
A = uniform amounts
A A A A A G
0

∞ N ∞
0 1 2 3 4 N 0 1 2 3 4
i=interest i=interest
P = present rate per P rate per
equivalent period period

Receipts and disbursements that increase or decrease by

a uniform amount.
Uniform Arithmetic Gradient
• P = Present Worth of Annuity + Present Worth of Gradient

𝐺 1 − (1 + 𝑖)−𝑛 𝑛
𝑃" = [ − 𝑛
]
𝑖 𝑖 (1 + 𝑖)
A loan was to be amortized to four year-end
payments, starting at ₱5,000 and increasing
yearly by ₱400. If interest is at 5% per year,
compute for the total loan. What is the
equivalent annuity if paid in equal payments?
Your company just purchased a piece of equipment.
Maintenance costs are estimated at ₱120,000 for
the first year and are expected to rise by ₱30,000 in
each of the subsequent four years. How much
should be set aside in a “maintenance account” now
to cover these costs for the next five years? Assume
payments are made at the end of each year and an
interest rate of 6% per year.
Uniform Arithmetic Gradient
(n-1)G
3G
2G
0 G

∞
0 1 2 3 4 N

i=interest rate per period

F

The future worth of an arithmetic gradient cash flow is

given by
Uniform Arithmetic Gradient
• F = Future Worth of Annuity + Future Worth of Gradient

𝐺 (1 + 𝑖)𝑛 −1
𝐹" = [ −𝑛]
𝑖 𝑖
What is the equivalent future value of
an initial amount of ₱500, decreasing by
₱50 in the next five years with 10%
interest per annum?
Geometric Gradient Series with Uniform Rate
of Increase A (1+g) 1
(n+1)

A1(1+g)3
A1(1+g)2
A1(1+g)
A1

∞
0 1 2 3 4 N

i=interest rate per period

P F

Amount changes at the uniform rate, g

For i≠g
Geometric Gradient Series with Uniform Rate
of Increase
1 − (1 + 𝑔)𝑛 (1 + 𝑖)−𝑛
𝑃 = 𝐴[ ]
𝑖−𝑔
𝑛 𝑛
1+𝑖 − 1+𝑔
𝐹 =𝐴[ ]
𝑖−𝑔
Airplane ticket price for Manila to Davao will
increase 8% in each of the next four years. The
cost at the end of the first year will be ₱5,000.
How much should be put away now to cover a
student’s travel home at the end of each year
for the next five years? Assume 5% interest
rate.
A graduating civil engineering student is going to make
₱720,000 per year with Granite Construction. A total of 10%
of the CE’s salary will be placed in the mutual fund of their
choice. The CE can count on a 3% salary increase with the
standard of living increases for the 30 years of employment.
If the CE is aggressive and places their retirement in a stock
index fund that will average 12% over the course of their
career, what can the CE expect at retirement?
You have just begun your first job as an engineer and decide to participate in
the company’s retirement plan. You decide to invest the maximum allowed
by the plan which is 12% of your ₱480,000 salary. Your company has told you
that you can expect a minimum 4% increase in salary each year assuming
good performance and typical advancement within the company.
Assuming you stay with the company, the company matches your investment
in the retirement plan, expected minimum salary increases, and an interest
rate of 10%, how much will you have in your retirement account after 40
years?
“ Compound interest is the
eighth wonder of the world. He
who understands it, earns it;
he who doesn’t, pays it.”
Albert Einstein