Engineering

Economics
Engr. Joseph D. Retumban

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REVIEW
Examples of values of n:
SIMPLE INTEREST
1. 4 years: n = 4
3
2. 3 months: n = 12
P = principal or present worth 3. 90 days:
I = interest earned 90
3a. Ordinary: n = 360
F = future worth
90 90
n = number of interest period 3b. Exact: n = 365 or n = 366 if leap year

i = rate of interest per interest period 4. 2 years and 4 months: n = 2 + 12

4

𝐄𝐪𝐮𝐚𝐭𝐢𝐨𝐧𝐬: I = Pni
F = P + I = P(1 + ni)
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 n
REVIEW 𝐄𝐪𝐮𝐚𝐭𝐢𝐨𝐧𝐬: F=P 1+i
r
i=
m
COMPOUND INTEREST
n = mt

P = principal or present worth Examples of values of i and n:

I = interest earned Nominal interest rate, r =12%
F = future worth or compound amount Number of years of investment, t = 5 years
1. Compounded annually (m = 1)
n = total number of compoundings 0.12
i= ,n = 1(5)
i = effective interest per compounding period 1
2. Compounded semi − annually (m = 2)
r = nominal rate 0.12
i= ,n = 2(5)
2
m = number of compoundings per year 3. Compounded quarterly (m = 4)
t = number of years of investment 0.12
i= ,n = 4(5)
4
ER = effective interest 4. Compounded monthly (m = 12)
0.12
i= ,n = 12(5)
12

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REVIEW Interest earned in one year
𝐄𝐪𝐮𝐚𝐭𝐢𝐨𝐧𝐬: ER =
Principal at the beginning of the year
r m
COMPOUND INTEREST ER = 1 + m
−1

P = principal or present worth

I = interest earned
F = future worth or compound amount Note:
n = total number of compoundings 1. The effective rate of interest is the actual interest earned in
i = effective interest per compounding period one year period.
r = nominal rate
m = number of compoundings per year 2. Two nominal rates are equal if they have the same effective
t = number of years of investment rates.
ER = effective interest

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 Illustration:
REVIEW An electronic equipment costs P30,000. Maintenance cost
is P3,000 per year. The device will generate revenues of
P15,000 each year for 5 years after which the salvage value
is expected to be P12,000. Draw and simplify the cash flow
CASH FLOW DIAGRAMS: Conventions diagram.

1. The horizontal (time) axis is marked off in equal

increments, one per period, up to the duration or horizon
of the project.
2. All disbursement and receipts (cash flow) are assumed to 12k
24k
take place at the end of the year in which they occur. This
is known as the year-end convention. The exception of the 15k 15k 15k 15k 15k 12k 12k 12k 12k
year-end convention is the initial cost (purchase cost)
which occur at 𝑡 = 0.
0 5
3. Two or more transfers in the same period placed end-to-
end may be combined into one.
0
3k 3k 3k 3k 3k
4. Expenses incurred before 𝑡 = 0 are called sunk cost and
are not relevant to the problem. 30k 30k
5. Receipts and disbursement are represented by arrows on
opposite sides of the horizontal time axis.

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Seatwork 2

For each problem, include a cash-flow diagram as part of the solution.

1. The amount of P20,000 was deposited in a bank earning an interest rate

of 6.5% per annum. Determine the total amount at the end of 7 years if the
principal and interest were not withdrawn during this period.

2. A P2,000 loan was originally made at 8% simple interest for 4 years. At the
end of this period, the loan was extended for 3 years, without the interest
being paid, but the new interest rate was made 10% compounded
semiannually. How much should the borrower pay at the end of 7 years?

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The amount of P20,000 was deposited in a bank earning an interest rate
of 6.5% per annum. Determine the total amount at the end of 7 years if
the principal and interest were not withdrawn during this period.

F
Given: Solution:
P = 20,000 F=P 1+i n

i = 6.5% = 0.065 F = 20,000 1 + 0.065 7 0

7
n=7 F = 𝑃31,079.73

20,000

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A P2,000 loan was originally made at 8% simple interest for 4 years. At the end of
this period, the loan was extended for 3 years, without the interest being paid, but
the new interest rate was made 10% compounded semiannually. How much
should the borrower pay at the end of 7 years?
F2
Given:
F1
P = 2,000
Simple Interest: First 4 years Compound Interest: Next 3 years 0

n=4 n=3 2 =6 4 7
10%
i = 8% = 0.08 i= = 5% = 0.05
2
2,000

simple interest compound interest

F1 = P 1 + ni F2 = F1 1 + i n

6
F1 = 2,000 1 + 4 0.08 F2 = 2,640 1 + 0.05

F1 = 𝑃2,640 F2 = 3,537.85 Restricted Distribution: Copyrighted Material

Example A man expects to receive P25,000 in 8 years. How much is that money
worth now considering interest at 8% compounded quarterly?

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Example A man expects to receive P25,000 in 8 years. How much is that money
worth now considering interest at 8% compounded quarterly?

Given: Solution:
r 8%
F = 25,000 i= = = 2% = 0.02
m 4
t=8
n = mt = 4 8 = 32
r = 8% = 0.08
m = 4 (compounded quarterly)
F=P 1+i n

F 25,000
Equation: P= n
= = 𝑃13,265.83
1+i 1 + 0.02 32
F=P 1+i n

r
i=
m
n = mt

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Example How many years will P100,000 earn a compounded interest of P50,000
if interests is 9% compounded quarterly?

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Example How many years will P100,000 earn a compounded interest of P50,000
if interests is 9% compounded quarterly?

Given: Solution:
P = 100,000 r 9% F 150,000
i= = = 2.25% = 0.0225 ln P ln 100,000
I = 50,000 m 4
n= =
ln 1 + i ln 1 + 0.0225
r = 9% = 0.09
F = P + I = 100,000 + 50,000 = 150,000 n = 18.22265221
m = 4 (compounded quarterly)
F=P 1+i n
F
= 1+i n n = mt
Equation: P
n 18.22265221
F=P 1+i n F t= =
ln = ln 1 + i n m 4
r P t = 4.56 years
i=
m F
n = mt ln = n ∗ ln 1 + i
P
F
ln P
n=
ln 1 + i Restricted Distribution: Copyrighted Material
Example Find the effective rate of interest corresponding to 8% compounded
quarterly.

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Example Find the effective rate of interest corresponding to 8% compounded
quarterly.

Given: Solution:
m 4
r 0.08
r = 8% = 0.08 ER = 1 + −1= 1+ − 1 = 0.0824 = 8.24%
m 4
m = 4 (compounded quarterly)

Equation:
r m
ER = 1 + −1
m

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Equation of Value

An equation of value is obtained by setting the sum of the values

on a certain comparison or focal date of one set of obligations
equal to the sum of the values on the same date of another set of
obligations.

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 A man bought a lot worth P1,000,000 if paid in cash. On the installment
Example basis, he paid a downpayment of P200,000; P300,000 at the end of one
year; P400,000 at the end of three years and a final payment at the end of
five years. What was the final payment if interest was 20%.

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 A man bought a lot worth P1,000,000 if paid in cash. On the installment
Example basis, he paid a downpayment of P200,000; P300,000 at the end of one
year; P400,000 at the end of three years and a final payment at the end of
five years. What was the final payment if interest was 20%.

Given: 𝐄𝐪𝐮𝐚𝐭𝐢𝐨𝐧: F=P 1+i n

Let Q = final payment

800,000
Solution:
Using today as the focal date, the equation of value is:
1 3 5 P0 = P1 + P3 + P5
P P P
0 800,000 = 300,000 , 20%, 1 + 400,000 , 20%, 3 + Q , 20%, 5
F F F
300,000 −1 −3 −5
800,000 = 300,000 1.20 + 400,000 1.20 + Q 1.20
𝑃 400,000
300,000 , 20%, 1 Q
𝐹 𝑃
400,000 , 20%, 3
𝐹 Q = 𝑃792,576
𝑃
Q , 20%, 5
𝐹

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 If money is worth 5% compounded quarterly, find the equated
Example time for paying a loan of P150,000 due in one year and P280,000
in 2 years.

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 If money is worth 5% compounded quarterly, find the equated
Example time for paying a loan of P150,000 due in one year and P280,000
in 2 years.

Given: 𝐄𝐪𝐮𝐚𝐭𝐢𝐨𝐧: F=P 1+i n

𝑃
Pt , 5%, 𝑛
𝐹 Pt Solution:
Using today as the focal date, the equation of value is:
1 2 Pt = P1 + P2
0
−4t −4(1) −4(2)
0.05 0.05 0.05
150,000 + 280,000 1+ = 150,000 1 + + 280,000 1 +
4 4 4
150,000

𝑃 n = 1.645491412 years
150,000 , 5%, 1 280,000
𝐹
n = 1.645 years
𝑃
280,000 , 5%, 2
𝐹

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 Peter borrowed P100,000 in a bank at 12% compounded annually. He
Example paid P20,000 on Year 1 and P30,000 on Year 2. How much must he pay
on Year 5 to wipe out the loan?

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 Peter borrowed P100,000 in a bank at 12% compounded annually. He
Example paid P20,000 on Year 1 and P30,000 on Year 2. How much must he pay
on Year 5 to wipe out the loan?

Given: 𝐄𝐪𝐮𝐚𝐭𝐢𝐨𝐧: F=P 1+i n

Let Q = final payment

100,000
Solution:
Using today as the focal date, the equation of value is:
1 3 5 P0 = P1 + P2 + P5
P P P
0 100,000 = 20,000 , 12%, 1 + 30,000 , 12%, 2 + Q , 12%, 5
F F F
20,000 100,000 = 20,000 1.12 −1
+ 30,000 1.12 −2
+ Q 1.12 −5
30,000
𝑃
20,000 , 12%, 1
𝑃 Q
𝐹
30,000 , 12%, 2
𝐹 Q = 𝑃102,615.94

𝑃
Q , 12%, 5
𝐹
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Discount
Discount on a negotiable paper is the difference between the present
worth (the amount received for the paper in cash) and the worth of the
paper at some time in the future (the face value of the paper or
principal).

Discount is the interest paid in advance.

• Trade Discount – the discount offered by the seller to induce trading.

• Cash Discount – the reduction on the selling price offered to a buyer to
induce him to pay promptly.

Discount = Future Worth − Present Worth

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Discount
The rate of discount is the discount on one unit of principal for one
unit of time.

1+i −1
d=1− 1+i −1

d 1
i= 0
1−d

Where d − rate of discount for the period involved 𝑃1.00

i − rate of interest for the same period

Illustration: If a negotiable paper, say a bond, can be sold for P100 seven
months from now, but is sold for P90 today, then P10 is the discount.
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 A man borrowed P5,000 from a bank and agreed to pay the loan at the end
Example of 9 months. The bank discounted the loan and gave him P4,000 in cash. (a)
What was the rate of discount? (b) What was the rate of interest? (c) What
was the rate of interest for one year?

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 A man borrowed P5,000 from a bank and agreed to pay the loan at the end
Example of 9 months. The bank discounted the loan and gave him P4,000 in cash. (a)
What was the rate of discount? (b) What was the rate of interest? (c) What
was the rate of interest for one year?

Solution:
Given:
Discount 5,000 − 4,000
a d= = = 0.20
Future Worth 5,000
= 20%
4,000 𝑃0.80

9 months 1 d 0.20
0 0 b i= = = 0.25 = 25%
1 − d 1 − 0.20

I 1,000
5,000 𝑃1.00 c i= = = 0. 3ത = 33. 3%
ത
Pn 4,000 9
12

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 Mr. T borrowed money from the bank. He receives from the bank P1,340
Example and promised to pay P1,500 at the end of 9 months. Compute: (a) simple
interest rate, and (b) discount rate.

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 Mr. T borrowed money from the bank. He receives from the bank P1,340
Example and promised to pay P1,500 at the end of 9 months. Compute: (a) simple
interest rate, and (b) discount rate.

Given: Solution:
F = 1,500 a F = P 1 + ni
P = 1,340
F 1,500
−1 −1
9 i= P
= 1,340
= 0.1592 = 15.92%
n= n 9
12 12

d
b i=
1−d
i 0.1592
d = 1+i = 1+0.1592 = 0.1373 = 13.73%

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 Find the discount if P2,000 is discounted for 6 months at
Example 8% simple interest.

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 Find the discount if P2,000 is discounted for 6 months at
Example 8% simple interest.

Solution:
Given: Discount
F = 2,000 a d=
Principal
d = 8% = 0.08
F−P 2,000
6 d= F
= 6 = 1,923.08
1+ 12 0.08
n=
12
D = F − P = 2,000 − 1,923.08 = P76.92

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Seatwork 3

1. Discount P1,650 for 4 months at 6% simple interest. What is the discount?

2. At a certain interest rate compounded semiannually, P5,000 will amount to P20,000 after 10
years. What is the amount at the end of 15 years?

3. A woman borrowed P3,000 to be paid after 1 ½ years with interest at 12% compounded
semiannually and P5,000 to be paid after 3 years at 12% compounded monthly. What single
payment must she pay after 3 ½ years at an interest rate of 16% compounded quarterly to
settle the two obligations.
4. Peter borrowed P100,000 in a bank at 12% compounded annually. He paid P20,000 on Year 1
and P30,000 on Year 2. How much must he pay on Year 5 to wipe out the loan? Solve this by
transferring all values to Year 5.

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Seatwork 3 Discount P1,650 for 4 months at 6% simple
#1 interest. What is the discount?

Given: Solution:
F = 1,650 F = P 1 + ni
i = 6% = 0.06 −1
4 −1
4
n= P = F 1 + ni = 1650 1 + 0.06 = 𝑃1,617.65
12 12

D = F − P = 1650 − 1617.65 = P32.35

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Seatwork 3 At a certain interest rate compounded semiannually,
P5,000 will amount to P20,000 after 10 years. What
#2 is the amount at the end of 15 years?

Given:
P = 5,000
F = 20,000
Solution:
m=2
t = 10 F=P 1+i n
20,000 = 5,000 1 + i 20
n = mt = 2 10 = 20
i = 0.07177 = 7.18%

F=P 1+i n

F = 5,000 1 + 0.0718 30 = P40,029.72

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 A woman borrowed P3,000 to be paid after 1 ½ years with interest at 12%
Seatwork 3 compounded semiannually and P5,000 to be paid after 3 years at 12%

#3 compounded monthly. What single payment must she pay after 3 ½ years
at an interest rate of 16% compounded quarterly to settle the two
obligations.

Given: Solution:
Let Q = final payment Compute F1.5 and F3 :
2 1.5
Q 0.12
F1.5 = 3000 1 + = 𝑃3,573.048
2
12 3
1 3 5 0.12
F3 = 5000 1 + = 𝑃7,153.844
12
0
F1.5
Project all values to Year 3.5.
F3 F 16% F 16%
Q = F1.5 , , 4 3.5 − 1.5 + F3 , , 4 3.5 − 3
P 4 P 4
F 16% 4 2 4 0.5
F3 , , 4 3.5 − 3 0.16 0.16
P 4 Q = 3573.048 1 + + 7153.844 1 +
4 4

F 16%
F1.5 , , 4 3.5 − 1.5
P 4 Q = 𝑃12,627.56 Restricted Distribution: Copyrighted Material
Seatwork 3 Peter borrowed P100,000 in a bank at 12% compounded annually. He
paid P20,000 on Year 1 and P30,000 on Year 2. How much must he
#4 pay on Year 5 to wipe out the loan? Solve this by transferring all
values to Year 5.

Given: Solution:
Let Q = final payment F F F
100,000 , 12%, 5 = 20,000 , 12%, 5 − 1 + 30,000 , 12%, 5 − 2 + Q
P P P
F
100,000 100,000 , 12%, 5 1 5 1 4 1 3
P 0.12 0.12 0.12
100,000 1 + = 20,000 1 + + 30,000 1 + +Q
1 1 1

1 3 5
Q = 𝑃102,615.94
0
20,000
30,000
Q
F
30,000 , 12%, 5 − 2
P

F
20,000 , 12%, 5 − 1
P
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