Scribd
Upload
4 views39 pages

Eco Module 3 Power Point (1)

Uploaded by

Joseph Sison
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
4 views39 pages

Eco Module 3 Power Point (1)

Uploaded by

Joseph Sison
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
You are on page 1/ 39

Engineering Economy

Module 3: Interest and Money – Time Relationships


(Part II)

Nominal and Effective Rates of Interest

Rate of interest is the cost of borrowing money. It also


refers to the amount earned by a unit principal per unit time.

There are two types of rates of interest, namely the


nominal rate of interest and the effective rate of interest.
Nominal rate of interest specifies the rate of interest and the
number of interest periods per year.

Formula Nominal Rate of Interest:

Where:
i = rate of interest per interest period
NR= nominal rate of interest
m = number of compounding periods per year
Effective rate of interest is the actual rate of interest on the
principal for one year and its 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.

Formula Effective Rate of Interest:

Formula Effective Rate of Interest Compounded


Continuously:
Problem 1: Find the interest rate per period of 8%
compounded quarterly and 10% compounded semi-annually.

Solution:

Nominal rate of interest of 8% compounded quarterly

Nominal rate of interest of 10% compounded semi-


annually
Problem 2: Determine the effective rate of interest of P1. 00
if invested at a nominal rate of 8% compounded quarterly.

Solution:

ie = or 8.24%
Problem 3: Calculate the rate of interest per interest period
and effective rate of interest corresponding to each of the
following rates:

a. 9% compounded semi-annually
b. 9% compounded quarterly
c. 9% compounded bi-monthly
d. 9% compounded monthly
Given:

(Semi-annually)
(Quarterly)
(Bi-monthly)
(Monthly)

Required:
Interest rate per period
Effective Rate,
Solution:

Interest Rate per Interest Period Effective Rate of


Interest
i

a. 9% compounded semi-annually

b. 9% compounded quarterly
c. 9% compounded bi-monthly

d. 9% compounded monthly
Problem 4: Which of these gives the lowest effective rate
of interest?

a. 12. 35% compounded annually


b. 11. 90% compounded semi-annually
c. 12. 20% compounded quarterly
d. 11. 60% compounded monthly
Given:

(Annually)
(Semi-annually)
(Quarterly)
(Monthly)

Required:

Lowest Effective Rate,


Solution:

12.35% compounded annually

11.90% compounded semi-annually

12.20% compounded quarterly

11.60% compounded monthly

Lowest Effective Rate is d,


Equivalent Rates

Two nominal rates are equivalent if they have the same


effective rates.

Problem 1: 12 % compounded monthly to a rate


compounded quarterly

(Effective rate of interest) monthly = {Effective rate of interest) quarterly

=
NR = 12.12% compounded
quarterly
Problem 2: What nominal rate compounded semi-annually
yield the same amount as 16% compounded quarterly.

(Effective rate of interest)quarterly = (Effective rate of interest)semi annually

NR = 16.32 % compounded semi


annually
Compound interest

Compound interest is the interest earned by the principal


when invested at compound interest.

0 1 2 n

P F
Cash Flow Diagram
Formula:

Where:
F = future amount
I = interest rate per period
n = total number of periods
P = present worth
m = number of compounding periods
t = number of years
Note: = single payment compound amount factor
Derivation of Formula

Period Principal Interest Total Amount


1 P Pi P + Pi = P(1 + i)
2 P(1 + i) P(1 + i)i P(1 + i)(1 + i) = P(1 + i)2
3 P(1 + i)2 P(1 +i)2i P(1 + i)2(1 + i) = P(1 + i)3
n P(1 + i)n
Problem 1: If the sum of P12, 000 is deposited in an
account earning interest at the rate of 9% compounded
quarterly, what will it become at the end of 8 years?

Given:
Required:

Future Interest,

Solution:
Problem 2: Mr. J. Dela Cruz borrowed money from a bank.
He receives from the bank P1,340 and promised to pay
P1, 500 at the end of 9 months. Determine the following:
a. Simple interest rate
b. The corresponding discount rate or often referred to as
the “banker’s discount”
Given:

n
Required:

Simple Interest Rate,


Discount Rate, d

Solution:

a. Simple interest rate


b. The corresponding discount rate or often referred to as
the “banker’s discount”
Continuous Compounding

The concept of continuous compounding is based on


the assumption that cash payments occur once per year but
compounding is continuous throughout the year.

The basic equation for future worth of compound


interest is .

But for m periods per year.


Continuous compounding single payment compound
factor .

Where:
P = principal
i = rate of interest
t = number of years
m = mode of payments
ern = continuous compounding compound amount
factor

Note: Cash flow diagram refers to the diagram where money


is projected as a function of time.
Problem 1: If P5, 000 shall accumulate for 10 years at 8%
compounded quarterly, find the compounded interest at the
end of 10 years.

Given:

Required:
Compound Interest,
Solution:
Problem 2: How many years are required for P1, 000 to
increase to P2, 000 if invested at 9% per year compounded
annually, semi-annually, quarterly, monthly, daily and
continuously?

Given:
Required: t
Compounded annually
Semi-annually

Quarterly

Monthly
Solution:

Compounded Annually:

Using either analytical or numerical method, the value of n will


be:
By Analytical:
By numerical: (using shift solve)

Compounded Annually:

Compounded Semi-Annually:
Compounded Quarterly:

Compounded Monthly:
Compounded Daily same to Compounded
Continuously:

Use the formula for continuous compounding


.
.
t = 7.70 years
Problem 3: What is the effective rate corresponding to 18%
compounded daily? Take 1 year is equal to 360 days.

Given:

Required:
Effective rate,
Solution:
Problem 4: What nominal rate, compounded semi –
annually, yields the same amount as 16% compounded
quarterly?

Given:

Required:
Nominal rate,
Solution:
The nominal rates are equal if they have the same
effective rate, then:

Using either analytical or numerical method, the value


of will be:
Problem 5: A nominal interest of 3% compounded
continuously is given on the account. What is the
accumulated amount of P10, 000 after 10 years?

Given:

Required:
Accumulated Amount,
Solution:

Alternative Solution:

(Note: r is also the nominal rate of interest)


Problem 6: How long will it take the money to triple itself if
invested at 10% compounded semi-annually?

Given:

Required:
t
Solution:

Compounded Semi-Annually:
Using either analytical or numerical method, the value of t will be:
By analytical:
References:

Fundamental of Engineering Economics by Chan S. Park 2004


Engineering Economy by Jaime R. Tiong 2002
Engineering Economy 10th Edition by William Sullivan 1997
Engineering Economy 3rd Edition by Matias Arreola 1993
Engineering Economy 2nd Edition by Hipolito Sta. Maria 1993
Engineering economics 2nd Edition by Venancio I. Besavilla Jr. 1989

You might also like