1

E. ENGINEERING ECONOMICS
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1. Engineering Economics
• Engineering Economics – is the study of
the cost factors involved in engineering
projects, and using the results of such
study in employing the most efficient cost-
saving techniques without affecting the
safety and soundness of the project
 3

2. Definitions
• Investment – is the sum total of first cost
(fixed capital) and working capital which
is being put up in a project with the aim
of getting a profit.
• Fixed Capital – is a part of the investment
which is required to acquire or set up the
business.
• Working Capital – is the amount of money
set aside as part of the investment to keep
the project or business continuously
 4

2. Definitions (cont..)
• Demand – is the quantity of a certain commodity that is
bought at a certain price at a given place and time.
• Supply – is the quantity of a certain commodity that is offered
for sale at certain price at a given place.
• Perfect Competition – is a business condition in which a
product or service is supplied by a number of vendors and
there is no restriction against additional vendors entering the
market.
• Monopoly – is a business condition in which as unique
product or service is available from only one supplier and that
supplier can prevent the entry of all others into the market.
• Oligopoly – is a condition in which there are so few suppliers
of a product or service that action by one will almost result in
similar action by the others.
 5

2. Definitions (cont..)
• Law of Supply and Demand - “Under
conditions of perfect competition, the price of
a product will be such that supply and
demand are equal.”
• Law of Diminishing Returns – “When the use
of one of the factors of production is limited,
either in increasing cost or by absolute
quantity, a point will be reached beyond
which an increase in the variable factors will
result in a less than proportionate increase
output.”
 6

3. Interest
• Interest – is the money paid for the use of
borrowed money.
 7

4. Simple Interest
• Simple interest – is the interest paid on the
principal (money lent) only.
• I  Pni
• F P  I P  Pni P1  ni 
• Where:
• F = future value
• P = present value
• n = number of interest period
• i = interest rate per period
• I = interest
 8

4. Simple Interest (cont..)

• Two Types of Simple Interest
• 4.1 Ordinary simple interest , 1 year =
360 days
• 4.2 Exact simple interest, 1 year = 365
or 366 days
•
 9

5. Compound Interest
• Compound interest – is the interest which
is calculated not only on the initial
principal but also the accumulated
F P 1  i n of prior periods.
interest
•
• Single payment
F P , i %, n  1  i n compound amount factor
F=PF P , i%, n 
•
 10

5. Compound Interest (cont..)

• Single payment present worth factor =
• P F , i , n1  i  n
P  F P F , i %, n 
• Where:
• F = future value
• P = present value
• n = number of interest period
• i = interest rate per period
 11

6. Cash Flow Diagram

• Cash flow diagram – is a graphical
representation of cash flows drawn on a
time scale.
 12

7. Discount
• Discount – is the difference between the
future worth and the present worth of a
unit.
• Discount,
D F  P

• Rate of discount,
F P
d
F
 13

8. Nominal and Effective Rate of

Interest
• Nominal interest rates – is the cost of
borrowed money which specifies the rate
of interest and the number of interest
periods.
• Effective interest rates – is the actual rate
of interest on the capital and is equal to
the nominal rate if compounded annually.
Effective interest rate is greater than
nominal interest rates.
 14

8. Nominal and Effective Rate of

Interest (cont..)
• Let in = nominal interest rate or annual percentage
rate
• m = number of sub periods per year
m
• Effective interest rate =  i n 
i  1    1
 m

• Where:
• m = 2 for semi-annually
• m = 4 for quarterly
• m = 12 for monthly
• m = 6 for bi-monthly
• m = 360 for daily
 15

9. Continuously Compounding
Interest Rate
•
F  Pe rt
• Where:
• F = future value
• P = principal or present value
• r = continuously compounding interest
rate
• t = number of interest periods
 16

10. Annuity
• Annuity – is a series of equal payments
occurring at equal intervals of time.

• Amortization – is a payment of debt by

installment usually by equal amounts and
at equal intervals of time.
 17

10.1 Applications of annuity

• 10.1.1 Installment purchase.
• 10.1.2 Amortization of loan.
• 10.1.3 Depreciation
• 10.1.4 Payment of insurance
premiums.
 18

10.2 Types of annuity

• 10.2.1 Ordinary Annuity – payments
occur at the end of each period.
• 10.2.2 Annuity Due – payments occur
at the beginning of each period.
• 10.2.3 Deferred Annuity – first
payment occurs later than at the end of
the first period.
• 10.2.4 Perpetuity – an annuity that
continues indefinitely.
 19

11. Ordinary Annuity

 20

11. Ordinary Annuity (cont..)

• Uniform series compound amount factor =
• F A , i %, n  1  i  n
1
i
F AF A , i %, n 
• Uniform seriesi sinking fund factor =
• A F , i %, n 1  i n  1
A  F A F , i %, n 
i 1  i n
A P , i%, n
• Capital recovery factor = 1  i n  1
A  PA P , i %, n 

•
 21

11. Ordinary Annuity (cont..)

• Uniform series present worth factor =
• 1  i n  1
P A , i %, n  
i 1  i n
P  AP A , i %, n 

• Where:
• F = future value of the periodic payments at the end
of n periods.
• P = present value of the periodic payments
• A = Annuity or periodic payments
• n = number of periodic payments
• i = interest rate per period
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12. Annuity Due

 23

12. Annuity Due (cont..)

P  A  AP A ,i %,4

F  PF P ,i %,5

F P 1  i 5
 24

13. Deferred Annuity

 25

13. Deferred Annuity (cont..)

P  AP A , i %,5P F , i %,3

F  PF P ,i %,8

F  P1  i 8
 26

14. Perpetuity
•
A
P
i
• Where:
• P = present value of the perpetuity
• A = Annuity or periodic payments
• i = interest rate per period
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15. Arithmetic Gradient

• Arithmetic-gradient present worth factor
= 1  i n
P G , i%, n 2 n1  n n
i 1  i  i 1  i 

• Arithmetic-gradient
1  i n  1 n future worth factor =
F G , i%, n 2 
i i

1 n
A G , i %, n  
• Arithmetic-gradient
uniform-series factor
i 1  i n  1
=
 28

15. Arithmetic Gradient (cont..)

•
 29

15. Arithmetic Gradient (cont..)

•
PG G P G , i %, n 

AG G A G , i %, n 

FG PG F P , i %, n G F G , i %, n 

• Where:
• AG = Equivalent annual amount of
gradient series.
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16. Geometric Gradient

 31

16. Geometric Gradient (cont..)

   1 g n 
 A1 1    
   1  i  
Pg  g i
 i g
 n
A1 g i
 1 i

Fg  Pg F P , i %, n 
 32

17. Depreciation
• Depreciation – is the decrease in value of
a physical property due to the passage of
time. Depreciation of a property is an
example of capitalization.
 33

17.1 Types of Depreciation

• 17.1.1 Physical depreciation – is a type
of depreciation caused by the lessening of
the physical ability of the property to
produce results, such as physical damage,
wear and tear.
• 17.1.2 Functional depreciation – is a
type of depreciation caused by the
lessening in the demand for which the
property is designed to render, such as
obsolescence and inadequacy.
 34

17.2 Purposes of
Depreciation
• 17.2.1 To provide for the recovery of
capital invested in the property.
• 17.2.2 To enable the cost of
depreciation to be charged to the cost of
producing the products turned out by the
property.
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17.3 Depreciation Terms

• First Cost (FC) – is the total amount invested
on the property until the property is put into
operation.
• Economic Life (n) – is the length of time at
which a property can be operated at a profit.
• Valuation (Appraisal) – is the process of
determining the value or worth of a physical
property for specific reasons.
• Value – is the present worth of all the future
profits that are to be received through
ownership of the property.
 36

17.4 Classification of Values

• Market value – is the price that will be paid
by a willing buyer to a willing seller for a
property where each has equal advantage
and is under no compulsion to buy or sell.
• Book value (BV) – is the worth of a
property as shown in the accounting
records of an enterprise.
• Salvage or resale value (SV) – is the price
of a property when sold second-hand; also
called trade-in value.
 37

17.4 Classification of Values (cont..)

• Scrap value (SV) – is the price of a
property when sold for junk.
• Fair value – is the worth of a property as
determined by a disinterested party which
is fair to both seller and buyer.
• Use value – is the worth of property as an
operating unit.
• Face or par value (F) – is the amount that
appears on the bond which is the price at
which the bond is first bought.
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18. Methods of Computing

Depreciation
 39

18.1 Straight Line Method

• Straight line method – is a method of
computing depreciation in which the
depreciation has the same value each
year.
• Annual
FC  SV
Depreciation =
d
n

• Book Value FC 
for
SV
m years.
 
BV  FC  m 
•  n 
 40

18.1 Straight Line Method

• Depreciation rate (d) – is the annual rate
for reducing the value of a property using
depreciation method.
• Depreciation rate =

Annual Depreciati on
First Cost
 41

18.2 Sinking Fund Method

• Sinking fund method – is a method of
computing depreciation in which the
initial depreciation is low.
• Annual Depreciation =
FC  SV FC  SV
d 
F A , i%, n  1  i n  1
i
• Where:
• i = interest rate or worth of money
 42

18.2 Sinking Fund Method (cont..)

• Book Value for m years.

 1  i n  1 
BV  FC  d  
 i 
 43

18.3 Sum-of-the-Years-Digits (SOYD)

Methods
• SOYD – is a method of computing
depreciation in which the digits from year
1 to year n are added and the
depreciation in a certain year decreases
by a constant
nn 1 amount each year.
T SOYD 
2
 n  k 1 
d k   FC  SV 
 T 

n
d1   FC  SV 
T 
 44

18.3 Sum-of-the-Years-Digits (SOYD)

Methods (cont..)
 n  1
d 2   FC  SV 
 T 

 n 2
d 3   FC  SV 
 T 

• Etc.
• Book Value for m years.
• BV FC  d1  d 2  d 3   d m 
 45

18.4 Declining Balance

Method
• (Also called Diminishing Balance Method,
Matheson Method, Constant-Percentage
or Constant Ratio Method).
SV  FC 1  r n

d k r FC 1  r k  1
d1 r FC 

d 2 r FC 1  r 

d 3 r FC 1  r 2
 46

18.4 Declining Balance

Method
• Etc.
• Book Value for m years.
• BV FC 1  r m
 47

18.5 Double Declining Balance

Method
• Double declining balance method – is a
method of computing depreciation in
which the depreciation of salvage and the
book value never stops decreasing.
Double declining balance is dependent on
accumulated depreciation.
L
 2
SV  FC  1  
 L
 48

18.5 Double Declining Balance

Method (cont..)
k 1
2  2
d k  FC  1  
L  L
2
d1  FC 
L
2  2
 
d 2  FC  1  
L  L
2
2  2
d 3  FC  1  
L  L
• Etc.
 49

18.5 Double Declining Balance

Method (cont..)

Book Value for m years.

m
 2
BV  FC  1  
 L
 50

18.6 Service Output or Production

Units Method
• Service output method – is a method of
computing depreciation in which
depreciation is calculated based on the
total production produced per year.
• Depreciation per unit,
FC  SV
d
No. of units capacity
 51

18.7 Working Hours or Machine

Hours Method
• Depreciation per hr,
FC  SV
d
No. of hours capacity
 52

19. Depletion
• Depletion - is the decrease in value of
property due to the gradual extraction of
its contents, such as mining properties, oil
wells, timber lands and other consumable
resources.
 53

19. Depletion (cont..)

• Two Methods of Depletion
• 19.1 Cost Depletion – is based on the level
of activity or usage, not time, as in
depreciation. It may be applied to most
types of natural resources.
• Cost depletion factor for year t is the ratio
of the first cost of the resource to the
estimated number of units recoverable.
first cost
pt 
resource capacity
 54

19. Depletion (cont..)

• The annual depletion charge is pt times
the year’s usage or volume. The total cost
depletion cannot exceed the first cost of
the resource. If the capacity of the
property is reestimated some year in the
future, a new cost depletion factor is
determined based upon the undepleted
amount and the new capacity estimate.
 55

19. Depletion (cont..)

• 19.2Percentage Depletion – is a special
consideration given for natural resources. A
constant, stated percentage of the resource’s
gross income may be depleted each year provided
it does not exceed 50% of the company’s taxable
income. For oil and gas property, the limit is 100%
of taxable income. The annual depletion amount is
calculates as
• Percentage depletion amount = percentage x
gross income from property
• Using percentage depletion, total depletion
charges may exceed first cost with no limitation.
 56

20. Capital Recovery (Factors of

Annual Cost)
• 20.1 Using Sinking Fund Method
• Capital Recovery = Annual Depreciation
+ Interest on Capital
FC  SV
• Annual Depreciation = n
1  i   1
i

• Interest on Capital =iFC 

 57

20. Capital Recovery (Factors of

Annual Cost) – (cont..)
• 20.2 Using Straight Line Method
• Capital Recovery = Annual
Depreciation + Average Interest
FC  SV
• Annual Depreciation = n
•

• Interest on Capital =i  n 1  FC  SV  iSV 

2 n 
 58

21. Capitalized Cost

• Capitalized Cost – is the sum of the first
cost and the present worth of all cost of
replacement, operation, and maintenance
for a long time.
• Methods of Computing Capitalized Cost
• 21.1 For perpetual life.
OM
FC 
i
• Capitalized Cost =
 59

21. Capitalized Cost (cont..)

• 21.2For life n.

OM FC  SV
• Capitalized Cost FC
= 
i 1  i n  1

• Where:
• OM = annual operation and maintenance
cost.
 60

22. Break-Even Analysis

• Break-even analysis – is a method of
determining the income to equal the
expenses or the costs of two alternatives
are equal.

• Break-even point – is the value of a

certain variable for which the costs of two
alternatives are equal.
 61

22. Break-Even Analysis

(cont..)
•
 62

22. Break-Even Analysis

(cont..)
• Income = Expenses
• Px  M x  Lx  V x  FC
• Where:
• x = no. of units produced and sold
• P = selling price per unit
• M = material cost per unit
• L = labor cost per unit
• V = variable cost per unit
• FC = first cost
 63

23. Business Organizations

• Types of Business Organizations (Forms
of Business or Company Ownership)
• 23.1 Individual Ownership or Single
Proprietorship - Is also termed as sole
proprietorship and is the type of
ownership in business where individual
exercises and enjoy rights in their own
interest. The owner has the total control
of the business and makes all decisions.
 64

23. Business Organizations

(cont..)
• 23.2Partnership – is also termed as general
partnership and is an association of two or
more individuals for the purpose of operating a
business as co-owners of a profit.
• 23.3 Corporation – is an artificial being created
by operation of law, having the right of
succession and the powers, attributes, and
properties expressly authorized by law or
incident to its existence. It is an association of
not less than five but not more than 15, all of
legal age.
 65

23. Business Organizations

(cont..)
• Private corporation – are those formed for some
private purpose or benefits.
• Public corporation – are those formed or organized
for the government.
• Semi-public corporation – are those formed that is
partly government and partly a private individual.
• Quasi-public corporation – are those formed for
public utilities and contracts, involving public duties
but which are organized for profit.
• Non-profit organization – are those formed for
community service and religious activities, but
organized for non-profit.
 66

23. Business Organizations

(cont..)
• Four Classes of Persons Composing a
Corporation
• 23.3.1 Corporators – are those who
compose the corporation.
• 23.3.2 Incorporators – are those
corporators originally (5-15) forming and
composing the corporation.
• 23.3.3 Stockholders – are owners of shares
of stock.
• 23.3.4 Members – are corporators of
corporation who has no capital stock.
 67

23. Business Organizations

(cont..)
• Stock – a certificate of owners
corporation
• a. Common stock – a residual owners of
a corporation.
• b. Preferred stock – which entitles the
holder thereof to certain preferences over
the holder of common stock.
 68

24. Contract
• Contract – is a legally binding agreement to
exchange services.
• 24.1 Four Basic Requirements in a Contract
• 24.1.1 There must be a clear, specific and
definite offer with no room for misunderstanding.
• 24.1.2 There must be some form of
conditional future payments.
• 24.1.3 There must be an acceptance of the
contract and the agreement must be voluntary.
• 24.1.4 Both parties must have legal capacity
and the purpose must be legal.
 69

24. Contract (cont..)

• 24.2Breach of contract – it occurs when one
party fails to satisfy all obligations of the
contract.
• 24.3 Negligence – is an action, whether willful
or unwillful, which is taken without proper
care for safety, resulting to property damages
or injury to persons.
• 24.4 Torts – a civil wrong committed by one
person causing damage to another person or
his property, emotional well-being, or
reputation.
 70

25. Bond
• Bond – a certificate of indebtedness of a
corporation usually for a period of not less
than 10 years and guaranteed by a
mortgage on certain assets of the
corporation or the subsidiaries.
• 25.1 Types of bonds
• 25.1.1 Mortgage bonds – a type of
bond in which the security behind are the
assets of the corporation.
 71

25. Bond (cont..)

• 25.1.2 Collateral bonds – a type of
bond in which the security behind are the
assets of a well known subsidiary.
• 25.1.3 Debenture bonds – a type of
bond in which there is no security behind
except a promise to pay.
 72

25.2 Bond Value

P Fr P A , i %, n  R P F , i %, n 
• Where:
• P = value of bond n periods before
maturity
• F = face or par value of the bond
• Fr = periodic dividend
• n = number of periods
• R = redeemable value (usually equal
to face or par value)
• i = investment rate
 73

26. Basic Investment Studies

• 26.1 Rate of return – usually stated in
percent per year and is an effective
annual interest rate.
• Rate of Return  Net Profit
Total Investment

• 26.2 Payout period – is the length of time

the investment can be recovered.
Total Investment  Salvage Value
Payout Period 
Net Annual Cash Flow
 74

27. Selection of Alternatives

• 27.1 Present Economy
• This involves selection of alternatives in which
interest or time value of money is not a factor.
Studies usually involve the selection between
alternative designs, materials, or methods.
• 27.2 Rate of Return
• Rate of return – is usually stated in percent per
year and is an effective annual interest rate.
The alternative which gives a higher rate of
return on investment is then the favorable
choice.
 75

27. Selection of Alternatives (cont..)

• 27.3Payout Period
• Payout period – this usually expressed in
years and is the length of time for the net
annual profit to equal the initial investment.
• 27.4 Annual Cost
• Annual Cost = Depreciation + Interest on
Capital + Operation and Maintenance +
Other out-of-pocket Expenses
• The alternative with a lower annual cost is
then the more economical alternative.
 76

27. Selection of Alternatives (cont..)

• 27.5 Present Worth
• Present Worth - is applicable when the
alternatives involve future expenses whose
present value can be easily determined.

• 27.6 Future Worth

• Future Worth – is applicable when the
alternatives involve expenses whose future
worth is more suitable basis of comparison.
•
 77

28. Replacement Studies

• Replacement studies – is an application of
selection of alternatives in which the
alternatives are to replace the old
equipment with a new one or to continue
using the old equipment.
• 28.1 Rate of Return
Savings Incurred By Replacement
Rate of Return 
Additional Capital Required
 78

28. Replacement Studies

(cont..)
• 28.2 Annual Cost
• Annual Cost = Depreciation + Interest on
Capital + Operation and Maintenance +
Other out-of-pocket Expenses

• In computing depreciation and interest of

the old equipment in either method,
actual present realizable values and not
historical values should be used.
 79

29. Benefit-to-Cost Ratio in Public

Projects
• Benefit-to-Cost Ratio – is commonly used
in public project evaluations where
present worth of all benefits is divided by
the present worth of all costs.
 80

29. Benefit-to-Cost Ratio in Public

Projects
•
 81

29. Benefit-to-Cost Ratio in Public

Projects
• Where:
• FC = first cost
• SV = salvage value at the end of life
• n = useful life
• OM = annual operation and maintenance
cost
• i = interest rate or worth of money
• B = annual benefits, that is, the annual
worth of benefits incurred because of the
existence of the project.
 82

29. Benefit-to-Cost Ratio in Public

Projects
• C = annual equivalent of the cost
• C FC A P , i%, n  SV A F , i%, n 

• Benefit-to-Cost Ratio
• B  OM
BC
C

• B/C should be greater than 1 for the

project to be justifiable.
 83

30. Economic Order Quantity

• Economic order quantity (E O Q) – is the order
quantity which minimized the inventory cost per
unit time. An assumption of the basic (E O Q) with
no shortages: “There is no upper bound on the
quantity ordered.”
• 2ak
E OQ 
• Where: h
• a = the constant depletion rate (items per unit
time)
• k = the fixed cost per order, Pesos
• h = the inventory storage cost (Pesos per item per
unit time)
 84

31. Principles of Accounting

• 31.1 Bookkeeping System
• Bookkeeping system – is used to record
all financial transactions of the company.
All transactions are recorded in a journal
then categorized and posted in a ledger. A
ledger is classified into asset, liability and
owner’s equity.
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31. Principles of Accounting (cont..)

• 31.2Balancing System
• Balancing system – where balancing the book means
maintaining the equality of the basic accounting
equation:
• Assets = Liability + Owner’s Equity

• Double entry bookkeeping system - is a balancing

system by maintaining the equality by entering each
transaction into two ledger accounts. All
transactions are either debits or credits. For liability
and owner’s equity, credit increases the account and
debt decreases the account.
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31. Principles of Accounting (cont..)

• 31.3Cash System
• Cash system – is the simplest form of
bookkeeping system and transactions
recorded into the journals are the present
cash and expenses.
• 31.4 Financial Statements
• Financial statements – the process of
determining the success or failure of the
company. Financial statements are usually
evaluated by accountants, business
management and stockholders.
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31. Principles of Accounting (cont..)

• 31.4.1 Two Types of Financial Statements
• 31.4.1.1 Balance sheet – is the presentation
of the basic accounting equation.
• 31.4.1.2 Profit and loss statement – is the
presentation of income source and expenses.
This is also known as statement of income and
retained earnings. Examples of income or
revenue are sales, interest, etc. and for
expenses are salaries, supplies, utilities, etc.
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31. Principles of Accounting (cont..)

• 31.4.2 Terms used in the Balance Sheets
• 31.4.2.1 Current assets – also known as liquid
assets and defined as cash and other assets
that can be converted quickly into cash such as
accounts receivable and merchandise.
• 31.4.2.2 Fixed assets – are properties that
will not be converted into cash or difficult to
convert into cash such as buildings, land,
machinery, equipment and fixtures.
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31. Principles of Accounting (cont..)

• 31.4.2.3 Current liabilities – are
liabilities which will due within a short
period, usually a year such as accounts
payable and accrued expenses.
• 31.4.2.4 Long-term liabilities – are
liabilities that are not payable within a
short period of time such as notes payable
and mortgage.
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31. Principles of Accounting (cont..)

• 31.4.3 Terms used in the Financial
Statements
• 31.4.3.1 Current ratio – an index of short
term paying ability.
Current Assets
Current Ratio 
• Current Liabilities

• 31.4.3.2 Acid-test ratio – also known as

quick ratio and defined as measure of
short-term
Acid  Test Ratio 
paying ability.
Quick Assets
Current Liabilities
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31. Principles of Accounting (cont..)

• 31.4.3.3 Receivable turn-over –
measures the speed of collections of
accounts receivables. Net Sales on Credit
Receivable Turnover 
• Average Receivables

• 31.4.3.4 Gross margin – gross profit as a

percentage of sales.
Gross Profit
• Gross Marg in 
Net Sales
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31. Principles of Accounting (cont..)

• 31.4.3.5 Profit margin ratio – percentage
of sales that is net income.
• Net Income Before Tax
Profit Marg in Ratio 
Net Sales
• 31.4.3.6 Return on investment ratio –
percent return on the investment.
Net Income
Return on Investment 
Owner ' s Equity
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END