UNIVERSITY OF LA SALETTE,INC

COLLEGE OF ENGINEERING AND ARCHITECTURE

SANTIAGO CITY, PHILIPPINES

Module 5: Decisions Recognizing Risk

Introduction
Organizational decision making often occurs in the face of uncertainty about whether a decision
maker’s choices will lead to benefit or disaster. Risk is the potential that a decision will lead to a loss or
an undesirable outcome. 
In this module we will be learning uniform arithmetic, geometric gradient and bond which can
help us understand and limit the risk that we will be facing when this situation occurs.

Learning Outcomes
At the end of this module, you are expected to:
a. calculate different types of bonds;
b. solve problems involving uniform arithmetic; and
c. evaluate geometric gradient by applying engineering economic principles and select the
most economically efficient one.
Preassessment:
Instruction: On the last module we tackled about economic problems which deals with break-even
analysis and the different types of annuities, in connection with this calculate the following problems.
(write your solution on the attached sheet at the back of this module):
1. What is the present worth of a 3-year annuity paying P3000 at the end of each year, with the
interest at 8% compounded annually?
2. What annuity is required over 12 years to adequate with a future amount of P20000? Assume i =
6% annually.
Lecture
Topic 1: Uniform Arithmetic
Uniform arithmetic gradient is a series of disbursements or receipts that increases or decreases
in each succeeding period by constant amount.

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COLLEGE OF ENGINEERING AND ARCHITECTURE
SANTIAGO CITY, PHILIPPINES

the above cashflow can be converted into its equivalent annuity and uniform arithmetic gradient whose
present worth are P1 and P2, respectively.

the total present worth P is equal to

sum of P1 and P2, mathematically
P = P1 + P2
Also, the total future worth is
F = F1 + F2
Present Worth
Let P = present worth of the following uniform arithmetic gradient

1 2 3 4 ….. n-1 n

G G
¿¿ 2G
2G 3G
¿¿
3G (n-2)G
¿¿
(n−2)G
¿¿ (n-1)G

(n−1) G
¿¿
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COLLEGE OF ENGINEERING AND ARCHITECTURE
SANTIAGO CITY, PHILIPPINES

P=
G
¿¿
Factor out G
P = G[
1 eq. 1
¿¿
Multiply eq. 1 by (1 + i):
1 2
P (1+i) = G[ + eq. 2
(1+i) ¿¿

Subtract eq. 1 from eq. 2

1 2
P (1+i) – P = G[ +
( 1+i ) ¿¿
1
−¿ G[
¿¿

1
Let a1 =
( 1+i )
a2 =
1
¿¿
a =
3 1
¿¿
Solving for the common ratio, r
a1 1
r= = ¿
a2 ¿ ¿
a3 1
r= = ¿
a4 ¿ ¿
solving for the sum, S:
a1 (1−r )
n
S=
1−r
1
S= ¿¿
( 1+i )

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COLLEGE OF ENGINEERING AND ARCHITECTURE
SANTIAGO CITY, PHILIPPINES

S = ¿¿
S = 1−¿ ¿

S = 1−¿ ¿

S = 1−¿ ¿

Substitute values in eq. 3

Pi = G ¿
G
P= ¿ where: G = arithmetic gradient change in the periodic amounts at the end of each period
i

Future Worth
Let F = future worth of the uniform arithmetic gradient

F = P(1 + i)n
G
F= ¿
i
G
F= ¿
i
where: G = arithmetic gradient change in the periodic amounts at the end of each period

Equivalent Periodic Amount

let A = equivalent periodic amount

Using formula for annuity:

P = A¿¿
G
But P = ¿
i

A = G¿

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REPRODUCTION, DISTRIBUTION, UPLOADING, OR POSTING ONLINE IN ANY FORM OR BY ANY MEANS WITHOUT
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 UNIVERSITY OF LA SALETTE,INC
COLLEGE OF ENGINEERING AND ARCHITECTURE
SANTIAGO CITY, PHILIPPINES

Topic 2: Uniform Geometric Gradient

Uniform geometric gradient is a series consisting of end-of-period payments, where each
payment increases or decreases by a fixed percentage.

Present Worth

G G( 1+ r)
P= + ¿¿
( 1+i )
P = G¿
1+ r
Multiply by :
1+ r
G
P= ¿
1+ r
1+r
Let x =
1+i
G
P= ¿ eq. 1
1+ r
Let a1 = x
a2 = x2

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COLLEGE OF ENGINEERING AND ARCHITECTURE
SANTIAGO CITY, PHILIPPINES

a3 = x3
a 2 x2
r= = =x
a1 x
Sum of geometric progression, S:
n
a1 (1−r )
S=
1−x
n
x(1−x )
S=
1−x
Substitute in Eq. 3
n
P=
G x(1−x )
1+ r 1−x
P=
1+ r 1+i ( )[
G 1+r ( 1−x n )
1−x ]
( )
n
G 1−x
P= or P = G¿¿
1+ i 1−x

1+ r
Where: x= ≠ 1, thusr ≠ i
1+i
G = first payment at the end of the first period
(1+i) = rate of increase or decrease
When r = i, then x =1
Substituting values in Eq. 3

Gn
P=
1+ i

Future Worth

1+ r
When x = ≠ 1:
1+i
F = P (1+i)n

[
G ( 1−x )
]
n
F= 1+i n
1+ i 1−x
F = G¿
When x = 1, r = 1
F = P (1+i n ¿
Gn
F= (1+i¿ ¿ n
(1+i)

THIS MODULE IS FOR THE EXCLUSIVE USE OF THE UNIVERSITY OF LA SALETTE, INC. ANY FORM OF
REPRODUCTION, DISTRIBUTION, UPLOADING, OR POSTING ONLINE IN ANY FORM OR BY ANY MEANS WITHOUT
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 UNIVERSITY OF LA SALETTE,INC
COLLEGE OF ENGINEERING AND ARCHITECTURE
SANTIAGO CITY, PHILIPPINES

F =Gn(1+i¿ ¿ n−1

Examples
1. Maintenance cost for a new piece of manufacturing equipment is expected to be $5,000 in the
first year and increase $250 per year for every year thereafter. If the cost of funds is 10%, what is
the present worth cost of maintenance for the next 5 years?

Solution

Given: A = $5,000; G = $250; i = 10%; n = 5; P = ?

P= A
[
i ( 1+i )
n
+
] [
( 1+i )n −1 G ( 1+i ) n −1
i i ( 1+i ) n
−
n
(1+i ) n ]
P=$ 5 , 000
[ ] [
( 1+0 . 10 )5 −1 $250 ( 1+0 .10 )5 −1
0. 10 ( 1+ 0 .10 )
5
+ −
5
]
0. 10 0. 10 (1+0. 10 ) ( 1+0 . 10 ) 5
5
= $20,669

2. Production from a gas well is expected to decline over the next five years until production
revenues equal operating costs, at which point the well will be shut down. Net income for year 1
is projected to be $1.2 Million. Determine the gradient and the present worth equivalent value of
the five-year production from the well. The company uses a 10% rate of return for its planning
purposes.
Solution

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COLLEGE OF ENGINEERING AND ARCHITECTURE
SANTIAGO CITY, PHILIPPINES

P=$ 1200000
[ ]
0.10 ( 1+0.10 )
5
0.10 [
( 1+0.10 )5−1 $300000 ( 1+0.10 )5−1
+
0.10 (1+0.10 )
5
−
5
(1+ 0.10 ) 5 ]
= $2.49 Million

3. A mechanical contractor is trying to calculate the present worth of personnel salaries over the
next five years. He has four employees whose combined salaries thru the end of this year are
$150,000. If he expects to give each employee a raise of 5% each year, what is the present worth
of his employees' salaries at an interest rate of 12% per year?
Solution
the cash flow at the end of year 1 is $150,000, increasing by r = 5% per year.
Therefore, the present worth is:

P = G¿¿

Topic 3: Bonds
Bond is a financial security note issued by businesses or corporations and by the government as a
means of borrowing long-term fund. It may also be defined as a long-term note issued by the lender to the
borrower stipulating the terms of repayment and other conditions.
Bonds do not represent ownership of a business or corporation and therefore not entitled to share
of the profits. The bondholder has no voice in the affair of the business. However, the bondholder has a
more stable and secured investment than does of the holder of common or preferred stock of the business
or corporation.
Bonds are issued in certain amounts known as the face value or par value of the bond. When the
face value has been repaid, normally at maturity, the bond is said to be redeemed or retired. Bond rate is
the interest rate quoted in the bond.

The following illustrates the normal life cycle of a bond.

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COLLEGE OF ENGINEERING AND ARCHITECTURE
SANTIAGO CITY, PHILIPPINES

Value of a bond is the present worth of all the amounts the bondholder will receive through his
possession of the bond. The two payments that the bondholder will receive are the following:
A. Periodic payments as interest of the bond until it is redeemed.
B. Single payment upon maturity of bond. This payment is usually equal to the par value of the bond.
Derivation of the formula for the value of a bond:
Let Vn = value of bond n years before redemption
Vn = P1 +P2 eq. 1
Using formula for present worth annuity:
P1 = A ¿ ¿
P1 = Zr ¿ ¿
Using the formula for present worth of compound interest:

P2 =
F
¿¿
P2 =
C
¿¿
Substituting in Eq. 1

Vn = Zr ¿ ¿

Where: Z = par value of the bond

r = rate of interest on bond per period
C = redemption price of bond
i = interest rate per period
n = number of years before redemption

Example

A P1000 6% bond pays divided semiannually and will be redeemed at 110% on June 21, 2004. It is
bought on June 21, 2001 to yield 4% interest. Find the price of the bond.

Solution
Fr = 1,000 ( )
0.06
0.02
Fr = 30

Vn = Zr ¿ ¿

Vn = 30 ¿ ¿
Vn = 1,144.81 ans.

THIS MODULE IS FOR THE EXCLUSIVE USE OF THE UNIVERSITY OF LA SALETTE, INC. ANY FORM OF
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 UNIVERSITY OF LA SALETTE,INC
COLLEGE OF ENGINEERING AND ARCHITECTURE
SANTIAGO CITY, PHILIPPINES

Summary:

G
P= ¿
i
G
F= ¿
i
A = G¿

( )
n
G 1−x
P=
1+ i 1−x
P = G¿¿

Gn
P=
1+ i
F = G¿

F =Gn(1+i¿ ¿ n−1
Vn = Zr ¿ ¿

Reference:

Park, C. S. (2012). Fundamentals of Engineering Economics. Chan S. Park. Pearson Education.

Sullivan, W. G., Wicks, E. M., & Luxhoj, J. T. (2003). Engineering economy (Vol. 13). Upper Saddle River, NJ:
Prentice Hall.

THIS MODULE IS FOR THE EXCLUSIVE USE OF THE UNIVERSITY OF LA SALETTE, INC. ANY FORM OF
REPRODUCTION, DISTRIBUTION, UPLOADING, OR POSTING ONLINE IN ANY FORM OR BY ANY MEANS WITHOUT
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 UNIVERSITY OF LA SALETTE,INC
COLLEGE OF ENGINEERING AND ARCHITECTURE
SANTIAGO CITY, PHILIPPINES

INSTRUCTIONS: Copy and answer the following problems. Incomplete solutions will not
be credited. Work independently. (USE THE ATTACHED ANSWER SHEET)

I. Solve the following problems that involve arithmetic and geometric

gradients.

1. A newly acquired equipment requires an annual maintenance costs of P10,000. If the

annual maintenance cost is increased by 20% each year every year for 10 years, what is
the estimated present worth of the maintenance costs if money is worth 15%?
2. Engr. Carlos, believing that life begins at 40, decided to retire and start enjoying life at age
40. He wishes to have upon his retirement the sum of P 5,000,000. On his 21 st birthday, he
deposited a certain amount and increased his deposit by 15% each year until he will be 40.
If money is deposited in a super savings account which earns 15% interest compounded
annually, how much was his initial deposit?

II. Calculate the following problems.

3. You were offered a Land Bank certificate with a face value of P100,000. The bond is
bearing an interest of 6% per year payable semi-annually and due in 6 years. If you want
to earn 8% semi-annually, how much are you willing to pay for the certificate?
4. A local firm is establishing a sinking fund for the purpose of accumulating a sufficient
capital to retire its outstanding bonds at maturity. The bonds are redeemable in 10 years
and their maturity value P150,000. How much should be deposited each year if the fund
pays interest at the rate of 3%?
5. You purchase a bond at P5,100. The bond pays P200 per year. It is redeemable for P5,050
at the end of 10 years. What is the net rate of interest on your investment?

THIS MODULE IS FOR THE EXCLUSIVE USE OF THE UNIVERSITY OF LA SALETTE, INC. ANY FORM OF
REPRODUCTION, DISTRIBUTION, UPLOADING, OR POSTING ONLINE IN ANY FORM OR BY ANY MEANS WITHOUT
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 UNIVERSITY OF LA SALETTE,INC
COLLEGE OF ENGINEERING AND ARCHITECTURE
SANTIAGO CITY, PHILIPPINES

LEARNING MODULE
PCEA 008 – ENGINEERING ECONOMICS
MODULE 5: DECISIONS RECOGNIZING RISK

Topic 1: Uniform Arithmetic Gradient

Topic 2: Geometric Gradient
Topic 3: Bonds

ENGR. ERIKA G. LLABRES

THIS MODULE IS FOR THE EXCLUSIVE USE OF THE UNIVERSITY OF LA SALETTE, INC. ANY FORM OF
REPRODUCTION, DISTRIBUTION, UPLOADING, OR POSTING ONLINE IN ANY FORM OR BY ANY MEANS WITHOUT
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 UNIVERSITY OF LA SALETTE,INC
COLLEGE OF ENGINEERING AND ARCHITECTURE
SANTIAGO CITY, PHILIPPINES

LEARNING MODULE
PCEA 008 – ENGINEERING ECONOMICS

MODULE 6: DEPRECIATION AND AFTER-

TAX ECONOMIC ANALYSIS

Topic 1: Depreciation
Topic 2: Depletion
Topic 3: Capitalized Cost and Annual Cost

ENGR. ERIKA G. LLABRES

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