Module 1

INTRODUCTION TO
ENGINEERING ECONOMY

Engr. Gerard Ang

School of EECE
 Definition of Terms
 Engineering Economy – uses mathematical formulas
to account for the time value of money and to balance
current and future revenues and costs.

 Economics – is the science that deals with the

production, allocation and use of goods and services.
The two major subdivisions of economics are:
a. Macroeconomics is the study of the entire system
of economics.
b. Microeconomics is the study of how the systems
affect one business or parts of the economic system.
 Necessities and Luxuries

 Necessities – are products or services that are

required to support human and activities that
will be purchased in somewhat the same
quantity even though the prices vary
considerably.

 Luxuries – are products and services that are

desired by humans and will be purchased if
money is available after the required
necessities have been obtained.
 Consumer and Producer
Goods and Services
 Goods – is defined as anything that anyone wants
or needs.

 Services – would be the performance of any

duties or work for another; helpful or professional
activity.

 Marketing – refers to the distribution of goods and

services.

 Marketing a Product – refers to the advertising,

and other efforts to promote a products sale.
 Different Types of Goods
1. Consumer Goods – are those such as food and
clothing that satisfy human wants and needs.

2. Producer Goods – are those such as raw

materials and tools, used to make consumer
goods.

3. Capital Goods – are the machinery, used in the

production of commodities in producer goods.
 Supply and Demand
 Supply – refers to how many of a certain good or
services are available for people to purchase.

 Demand – means how many people wish to buy

that good or service.

 Law of Supply and Demand

Under conditions of perfect competition, the price
at which a given product will be supplied and
purchased is the price that will result in the supply
and demand being equal.
 Demand

 Demand – it refers to the people’s

willingness to buy a product or service.

 Demand Curve – is the plot or graph of the

quantity demanded versus the price.

 Demand Schedule – is the schedule or

table listing of the quantity demanded with
the corresponding price.
 Types of Demand
1. Elastic Demand – exists when there is a greater
change in quantity demanded as a response to a
change in price.

2. Inelastic Demand – exists when there is a lesser

change in quantity demanded as a response to a
change in price.

3. Unitary Demand – exists when there is an equal

change in price and quantity demanded (increase or
decrease).
 Factors that Influence Demand
Factors that Influence Demand are:
1. Income
2. Population
3. Taste and preference
4. Price Expectation
5. Price of Related Goods
 Supply

 Supply – it is the willingness of a

producer to manufacture goods.

 Supply Curve – is the plot or graph of the

quantity supplied versus the price.

 Supply Schedule – is the schedule or

table listing of the quantity supplied with
the corresponding price.
Factors that Influence Supply

Factors that Influence Supply are:

1. Price of Goods
2. Cost of Production
3. Availability of Resources
4. Number of Producer and Sellers
5. Technological Advancement
6. Taxes
7. Subsidies
 Relationship of
Supply and Demand
 Shortage – the supply is less than the
demand.

 Surplus – the supply exceeds the

demand.

 Equilibrium Point – the supply is equal

to the demand.
 Market Structures
 Market – is the place where the vendors and buyers meet to
transact.

 Perfect Competition – occurs in a situation where a commodity or

service is supplied by a number of vendors and there is nothing to
prevent additional vendors entering the market.

 Perfect Monopoly – exist when a unique product or services is

available from a single vendor and that the vendor can prevent the
entry of all others into the market.

 Oligopoly – exist when there are so few suppliers of a product or

service that action by one will almost inevitably result in similar
action by the others.
 Module 2
INTEREST & MONEY – TIME
RELATIONSHIPS

Engr. Gerard Ang

School of EECE
 Simple Interest

 Interest – is the return on capital

or cost of using capital. It is the 𝐈 = 𝐏𝐢𝐧 𝐅 = 𝐏+𝐈
amount of money paid for the
use of borrowed capital or the
income produced by money, 𝐅 = 𝐏(𝟏 + 𝐢𝐧)
which has been loaned.

 Simple Interest – is calculated Where:

I = interest
using the principal only, ignoring i = rate of interest
any interest that had been n = number of interest period
accrued in preceding period. P = principal or present worth
F = accumulated amount or future worth
 Types of Simple Interest

1. Ordinary Simple Interest – simple interest in which it is

assumed that each month contains 30 days and
consequently each year has 360 days.

1 month = 30 days
1 year = 360 days (banker’s year)

2. Exact Simple Interest – simple interest in which the

exact number of days per month is used.

1 ordinary year = 365 days

1 leap year = 366 days
 Sample Problems on
Simple Interest
1. A loan of Php50,000 is made for a period of 13 months, from
April 1 to April 30 of the following year, at a simple interest rate
of 20%. What future amount is due at the end of the loan
period?
2. What is the principal amount if the amount of interest at the
end of 2 ½ years is Php450 for a simple interest rate of 6% per
annum?
3. Determine the exact simple interest of Php25,000 for the
period of December 27, 2002 to March 23, 2003, if the rate of
interest is 10%.
4. What is the interest due on a Php1,500 loan for 4 years and
three months if it bears 12% ordinary simple interest?
5. Determine the exact simple interest of Php4,000 for the period
of Feb. 14, 1984 to November 30, 1984, if the rate of interest
is 18%.
 Compound Interest

Compound Interest – the

interest for an interest 𝐧
𝐫
𝐅 = 𝐏(𝟏 + 𝐢) 𝐢=
period is calculate on the 𝐦
principal plus total amount
of interest accumulated in 𝐏 = 𝐅(𝟏 + 𝐢)−𝐧 𝐧 =𝐦×𝐭
the previous period.
Compound interest means
“the interest on top of Where:
I = interest
interest.” i = rate of interest
n = number of interest periods
m = number of compounding periods
t = time
P = present worth
F = future worth
 Rates of Interest
 Rate of Interest – it is the cost of borrowing money.

 Nominal Rate of Interest – it specifies the rate of interest and a

number of interest periods in one year.

Where:
𝐫 i = interest rate per interest period
𝐢=
𝐦 r = nominal interest rate
m = number of compounding periods

 Effective Rate of Interest – it is the actual or exact rate of

interest on the principal during one year.
𝐄𝐑 = (𝟏 + 𝐢)𝐦 −𝟏 Where:
ER = effective rate
i = interest rate per interest period
𝐫 𝐦
r = nominal interest rate
𝐄𝐑 = 𝟏 + −𝟏 m = number of compounding periods
𝐦
 Values of “m”
 m = 1 for compounded annually (every 12 months)
 m = 2 for compounded semi-annually (every 6 months)
 m = 4 for compounded quarterly (every 3 months)
 m = 6 for compounded bi-monthly (every 2 months)
 m = 8 for compounded semi-quarterly (every 1 1/2 months)
 m = 12 for compounded monthly (every month)
 m = 24 for compounded semi-monthly (every 1/2 month)
 F/P and P/F Factors:
Notation and Equations

Factor Factor Standard Equation

Excel
Find/Given Notation with Factor
Notation Name Functions
Equation Formula

Single-
payment
(F/P,i,n) F/P F = P(F/P,i,n) F = P(1 + i)n FV(i%,n,,P)
compound
amount
Single-
payment
(P/F,i,n) P/F P = F(P/F,i,n) P = F(1 + i)-n PV(i%,n,,F)
present
worth
 Sample Problems on
Compound Interest
1. What rate of interest compounded annually must be received if
an investment of Php5,400 made now will result in a receipt of
Php7,200 5 years hence?
2. What amount will be accumulated by Php4,100 in 10 years at 6%
compounded annually?
3. What effective annual interest rate corresponds to the following
situations?
a.nominal interest rate of 10% compounded semi-annually
b.nominal interest rate of 6% compounded monthly
c.nominal interest rate of 8% compounded quarterly
4. How much should Engr. Cruz deposit now, if after 10 years, this
will amount to Php100,000. Interest rate is 12% compounded
semiannually?
5. If Php1,000 becomes Php5,734 after 15 years, when invested at
an unknown rate of interest compounded semi-annually,
determine the unknown nominal rate and corresponding effective
rate.
 Cash Flow Diagram

 Cash Flow Diagram – depicts the timing and

amount of expenses (negative, downward) and
revenues (positive, upward) for engineering
projects.

Receipt (positive cash

flow or cash inflow

Disbursement (negative
cash flow or cash outflow
Types of Cash Flow Diagrams

P-Pattern “present”
1 2 3 n

F-Pattern “future”
1 2 3 n

A-Pattern “annual”
1 2 3 n

G-Pattern “gradient”
1 2 3 n
 Equation of Value

An equation of value is obtained by setting

the sum of the values on a certain
comparison or local date (or focal date) of
one set of obligations equal to the sum of
the values on the same date of another set
of obligations.
 Sample Problems on
Equation of Value
1. Jay wishes his son, Jason, to receive
Php1,000,000 twenty years from now. What
amount should he invest now, if it will earn interest
of 12% compounded annually during the first five
years and 10% compounded monthly for the
remaining years.
2. Find the present worth of a future payment of
Php300,000 to be made in 10 years with an
interest rate of 10% compounded annually. What
will be the amount if it will be paid 5 years later (on
the 15th year)?
 Discrete Payments

The solution of discrete payments or number of

transactions occurring at different periods is taking each
transaction to the base year and equating each value.

Steps in Solving Discrete Payments:

1. Draw the cash flow diagram.
2. Select any convenient focal date.
3. Years on the left of the focal date have a positive sign
while years on the right of the focal date have a
negative sign.
4. Use the principle: Cash Inflow = Cash Outflow
 Sample Problems on
Discrete Payments
1. Acosta Holdings borrowed Php9,000 from Smith Corporation on
January 1, 1998 and Php12,000 on January 1, 2000. Acosta
Holdings made a partial payment of Php7,000 on January 1,
2001. It was agreed that the balance of the loan would be
amortized by two payments, one on January 1, 2002 and one
on January 1, 2003, the second being 50% larger than the first.
If the interest rate is 12%, what is the amount of each payment?
2. A contract has been signed to lease a restaurant at Php20,000
per year with annual increase of Php1,500 for 8 years.
Payments are to be made at the end of each year, starting one
year from now. The prevailing rate is 7%. What lump sum paid
today would be equivalent to the 8 year lease program?
3. Mr. Cruz buys a second hand car worth Php150,000 if paid in
cash. On installment basis, he pays Php50,000 downpayment,
Php30,000 at the end of one year, Php40,000 at the end of two
years and a final payment at the end of four years. Find the final
payment if interest is 14%.
 Continuous
Compounding Interest

The solution for interest compounded continuously

can be derived thru differential equations and can be
found as:

Where:
𝐝𝐏 i = interest rate compounded continuously
= 𝐢𝐏
𝐝𝐭 P = present worth
t = time
 Sample Problems on
Continuous Compounding Interest
1. Philip invested $100 on a bank. The bank offers
5% interest compounded continuously in a
savings account. Determine (a) how long will it
require for him to earn $5 (b) the equivalent
simple interest rate for 1 year of the bank.
2. Which is more advisable to invest Php5,000 for
five (5) years, to bank A that offers 5%
compounded continuously or to bank B that
offers 10% simple interest?
 Banker’s Discount
Certain banks lend money in such a way that they
deduct the interest on the money. They actually don’t
lend you money you asked for. This type of computing
money is called banker’s discount. The money received
by the borrower after the discount has been deducted is
called proceeds.

Where:
𝟏 − (𝟏 + 𝐧𝐢)−𝐧 i = rate of interest
𝐝= d = rate of discount
𝐧
n = number of interest period
 Sample Problems on
Banker’s Discount
1. Ms. Glydel Marquez borrowed money from a bank.
She received from the bank Php1,342 and
promised to repay Php1,500 at the end of 9
months. Determine the following: (a) simple
interest rate (b) discount rate or often referred as
Banker’s discount.
Module 3
ANNUITY

Engr. Gerard Ang

School of EECE
 Annuity
 Annuity – it is a series of equal cash flows
occurring each period over a range of periods.

 Types of Annuity:
1. Ordinary Annuity
2. Deferred Annuity
3. Annuity Due
4. Perpetuity
 Ordinary Annuity
Ordinary Annuity – is a series of equal payments or
receipts occurring over a specified number of periods
with the payments or receipts occurring at the end of
each period. It is also referred as annuity-immediate.

0 1 2 3 n
𝟏 − (𝟏 + 𝐢)−𝐧 (𝟏 + 𝐢)𝐧 −𝟏
𝐏=𝐀 𝐅=𝐀
𝐢 𝐢

A A A A Where:
F P = present worth
A = series of periodic equal payments
P n = number of interest period
i = interest rate per interest period
 P/A and A/P Factors:
Notation and Equations
Factor Factor Standard
Factor Excel
Find/Given Notation
Notation Name Formula Functions
Equation

Uniform-
series 1 − (1 + 𝑖)−𝑛
(P/A,i,n) P/A P = A(P/A,i,n) PV(i%,n,A)
present 𝑖
worth

Capital 𝑖
(A/P,i,n) A/P A = P(A/P,i,n) PMT(i%,n,P)
recovery 1 − (1 + 𝑖)−𝑛
 F/A and A/F Factors:
Notation and Equations
Factor Factor Standard
Factor Excel
Find/Given Notation
Notation Name Formula Functions
Equation

Uniform-
series (1 + 𝑖)𝑛 −1
(F/A,i,n) F/A F = A(F/A,i,n) FV(i%,n,A)
compound 𝑖
amount

𝑖
(A/F,i,n) Sinking fund A/F A = F(A/F,i,n) PMT(i%,n,,F)
(1 + 𝑖)𝑛 −1
 Sample Problems on
Ordinary Annuity
1. What is the current value of a $50 payment to be made at
the end of each of the next three years if the prevailing
rate of interest is 7% compounded annually?
2. An obligation of Php20,000 is to be repaid in uniform
annual amounts each of which included repayment of the
debt and interest over a period of 5 years. If interest is
10% per year, what is the annual payment?
3. Maintenance cost for a small bridge expected to last for
60 years is estimated to be Php1,000 each for the first 5
years, followed by a Php10,000 expenditure in the 15th
year and Php10,000 in the 30th year. If interest is 10%
per year, what is the equivalent uniform annual cost over
the 60 year period?
 Sample Problems on
Ordinary Annuity
4. What is the equivalent previous worth of Php500
annuity to be paid constantly in 60 years 72 years ago, if
annual interest is 1%?
5. Find the annual payment to extinguish a debt of
Php10,000 payable for 5 years at 12% interest.
6. A savings loan is made between a man and banker. What
should be the uniform monthly payment that the man
should make if he is to borrow Php50,000 and he is to pay
in 10 years? Interest is taken as 6% compounded
quarterly.
7. What annuity is required over 10 years to equate with
the future amount of Php15,000. Assume i = 5%.
 Deferred Annuity
Deferred Annuity – are annuities that are computed
on different present year and/or future year. It is
annuity where the first payment is made several
periods after the beginning of the annuity.

0 1 2 3 n
Where:
k k = number of deferred periods

A A A A
F
P
 Methods of Solving
Deferred Annuity Problems
1. Draw the cash flow diagram.
2. Select any convenient focal date.
 Temporary focal date is used to convert deferred annuity to
ordinary annuity
 Final focal date is used to obtained the required value.
3. Project all values to temporary focal date.

𝟏 − (𝟏 + 𝐢)−𝐧
𝐏′ = 𝐀
𝐢

4. Obtain the final value.

Where:
𝐏 = 𝐏′(𝟏 + 𝒊)−𝒌 k = number of deferred periods
 Sample Problems on
Deferred Annuity
1. Find the value of x in the cash flow diagram, given
that would make the equivalent present worth of the
cash flow diagram to Php22,000 and interest rate is
at 13% per year.
1, 000 per 5x
year

0 2
1 3 4 5 6 7 8 9 10 11

22, 000
 Sample Problems on
Deferred Annuity
2. Determine the uniform annual payments which would
be equivalent to the cash flow diagram given. Interest
rate of 12% per year.

0 1 2 3 4 5 6 7 8 9
years

1,200
2,000

3,000
 Annuity Due
Annuity Due – is a series of equal payments or
receipts occurring over a specified number of periods
with the payments or receipts occurring at the
beginning of each period.
𝟏− 𝟏+𝐢 −𝐧
0 1 2 3 n 𝐏=𝐀 (𝟏 + 𝐢)
𝐢

𝟏+𝐢 𝐧−𝟏
𝐅=𝐀 (𝟏 + 𝐢)
𝐢
A A A A A
F Where:
P P = present worth
A = series of periodic equal payments
n = number of interest period
i = interest rate per interest period
 Sample Problems on
Annuity Due
1. What is the current value of a $50 payment to be
made at the beginning of each year, for three years if
the prevailing rate of interest is 7% compounded
annually?
2. What is the accumulated value of a $25 payment to
be made at the beginning of each of the next three
years if the prevailing rate of interest is 9%
compounded annually?
 Perpetuity
 Perpetuity – are uniform payments which
are done infinitely. It is also called as
perpetual annuity.
0 1 2 3 ∞

A A A A
F
P
 Types of Perpetuity
0 2 ∞
1. Ordinary Perpetuity – first 1 3

payment is done one period

after the focal date.
A A A A
𝐀
𝐏= F
𝐢 P

0 1 2 3 8
2. Deferred Perpetuity – first
payment is done several k
periods after the focal date.
A A A
𝐀 F
𝐏 = (𝟏 + 𝒊)−𝒌
𝐢 P

Where: k = number of deferred periods

 Sample Problems on
Perpetuity
1. How much should Mr. Sy invest on a bank that offers
10% interest so that he would earn Php1,000 each
year in perpetuity.
2. Don Jose deposited Php5,000,000 on a bank that
earns 10% compounded annually. Five years later he
died. His will states that his beneficiary is an
orphanage which will be receiving the money in
perpetuity a year after he died. How much is the yearly
fund the orphanage will be receiving?
3. If money is worth 8% compounded quarterly, compute
the present value of the perpetuity of Php1,000
payable quarterly.
 Module 4
DEPRECIATION

Engr. Gerard Ang

School of EECE
 Definition of Terms
 Depreciation – it is the decrease in the value of a fixed
asset, or the value of physical property, with the
passage of time.
 Value – is the present worth of all the future profits that
are to be received through the ownership of a particular
property.
 Market Value of a Property – is the amount, which a
willing buyer will pay to a willing seller for the property
where each has equal advantage and is under no
compulsion to buy and sell.
 Definition of Terms
 Utility or Use Value of Property – is what the property
is worth to the owner as an operating unit.
 Fair Value – is the value which is usually determined by
the disinterested third party in order to established a price
that is fair to both seller and buyer.
 Book Value – is the worth of the property as shown in
the accounting records of an enterprise. It is sometimes
called as depreciated book value.
 Salvage or Resale Value – is the price that can be
obtained from the property after it has been used.
Salvage Year is the year when scrap value is equal to
book value.
 Scrap Value or Junk Value – is the price that can be
recovered if an asset is disposed as a junk.
 Purposes of Depreciation

1. To provide for the recovery of capital

which has been invested in physical
property.
2. To enable the cost of depreciation to be
charged to the cost of producing
products or services that results from
the use of property.
 Causes of Depreciation
 Physical Depreciation – it is due to wear and tear of
the asset.
 Functional Depreciation – it is due to the
obsolescence of the asset.
 Depletion – refers to the decrease in the value of a
property due to the gradual extraction of its contents.
 Monetary Depreciation – depreciation due to
changes in price level.
 Physical and Economic Life
 Physical Life of a Property – is the length of time
during which it is capable of performing the function
for which it was designed and manufactured.
 Economic Life or Useful Life – is the length of time
during which the property may be operated at a
profit.
 Methods Used to
Determine Depreciation
1. Straight Line Method
2. Declining Balance Method
3. Double Declining Balance Method
4. Sum-of-Years’ Digit Method
5. Sinking Fund Method
6. Hour Output Method
7. Service Output Method
 Straight Line Method
The straight line method is the simplest way in
computing for depreciation. In this method, the
depreciation each year is constant and the interest
rate is being neglected.
Where:
𝐕 − 𝐕𝐬
𝐝= V = original cost/value
𝐧
VS = salvage value
Va = book value
𝐕𝐚 = 𝐕 − 𝐚 × 𝐝 d = depreciation
D = total depreciation after n years
𝐃 = 𝐝×𝐧 n = economic life
a = depreciable year
 Sample Problems
on Straight Line Method
1. Prepare a depreciation table for an asset which was
bought at Php15,000 and useful for a period of 7 years.
Estimated salvage value is 10% of its original cost.
2. Equipment bought for Php60,000 is expected to last for 30
years. If the book value after 20 years is Php20,000, how
much is the depreciation each year? Find the book value
after 10 years.
3. A machine which costs Php10,000 was sold as scrap
after being used for 10 years. If the scrap value was
Php500, determine the total depreciation and book value
at the end of the 5th year.
 Sample Problems
on Straight Line Method
4. Delivery jeeps purchased by KH Company cost
Php180,000 each. Past records indicate that jeeps should
have an economic life of 10 years. They can be sold from
an average of Php50,000 each year after 10 years of use.
The company receives 9% interest on investment funds.
Using straight line method:
Determine:
a. the depreciation charge during 3 years
b. the depreciation reserve accumulated at the end of 3
years
C. book value at the end of 3 years.
Declining Balance Method or
Reducing Balance Method
In this method, the net book value at the end of each
period can be simply computed by multiplying the
original market price by a fix percentage repeatedly
until it reaches the salvage value. This method is also
called Matheson’s Formula.

𝐝𝐚 = 𝐤𝐕(𝟏 − 𝐤)𝐚−𝟏 𝐕𝐚 = 𝐕(𝟏 − 𝐤)𝐚

𝐧 𝐕𝐬 Where:
𝐤 =𝟏− k = depreciation factor or rate
𝐕
 Sample Problems on
Declining Balance Method
1. A machine worth Php800,000 is bought from China.
Freight charges amount to Php200,000. If the scrap
value of the machine is Php50,000 that occurs at
the end of 17 years. Compute (a) the depreciation
and (b) book value at the end of 11 years.
2. Equipment bought for Php60,000 is expected to last
for 30 years. If the scrap value after 20 years is
Php20,000. How much is the depreciation for year
10?
 Double Declining
Balance Method
This is the same as declining balance method except that
k is replaced by 2/n.
𝟐
𝐤=
𝐧

Sample Problem on Double Declining Balance Method

A plant bought a calciner for Php220,000 and used it for
10 years, the life span of the equipment. What is the book
value of the calciner after 5 years of use? Assume a scrap
value of Php20,000 for straight-line method; Php22,000 for
declining balance method and Php20,000 for double-
declining balance method.
 Sum-of-Years’ Digit Method
This method uses the year’s digit (in reverse order) in
computing for the depreciation.

𝐧+𝟏−𝐚 𝐧(𝐧 + 𝟏)
𝐝𝐚 = (𝐕 − 𝐕𝐬 ) 𝐒𝐘𝐃 =
𝐒𝐘𝐃 𝟐

𝐚 𝟐𝐧 + 𝟏 − 𝐚 𝒂 𝟏
𝐃= (𝐕 − 𝐕𝐬 ) 𝐚 𝐧− +
𝐧(𝐧 + 𝟏) 𝐕𝐚 = 𝐕 − 𝟐 𝟐 (𝐕 − 𝐕 )
𝐬
𝐒𝐘𝐃

Where: SYD = sum-of-years’ digit

 Sample Problem on
Sum of Years’ Digit Method
An industrial plant bought a generator set for Php90,000.
Other expenses including installation amounted to
Php10,000. The generator set is to have a life of 17
years with a salvage value at the end of life at Php5,000.
Determine the depreciation charge during the 13th year
and the book value at the end of 13 years by:
(a) Declining balance method
(b) Double declining balance method
(c) Sum-of-Years’ digit method
 Sinking Fund Method
Sinking fund method presents the idea of annuity in
computing for the depreciation. The interest rate for
the worth of money is being considered so as to have
the depreciable value.

𝐢 (𝟏 + 𝐢)𝐚 −𝟏
𝐝 = (𝐕 − 𝐕𝐬 ) 𝐃 = (𝐕 − 𝐕𝐬 )
(𝟏 + 𝐢)𝐧 −𝟏 (𝟏 + 𝐢)𝐧 −𝟏
 Sample Problem
on Sinking Fund Method
A broadcasting company purchased an equipment for
Php53,000 and paid Php1,500 for freight and delivery
charges to the job site. The equipment has a normal life
of 10 years with a trade-in value of Php5,000 against the
purchase of a new equipment at the end of the life.
Determine the annual depreciation cost using:
(a) straight line method
(b) sinking fund method assuming interest is
6% compounded annually
 Hour Output method
In this method, the functionality period and the period
the machine has been used is considered.
Depreciation is computed based on the wear and tear
of the machine.

𝐡𝐚
𝐝𝐚 = (𝐕 − 𝐕𝐬 ) 𝐕𝐚 = 𝐕 − 𝐝𝐚
𝐇

Where:
H = total hours of economic life
ha = number of hours the asset has been used
 Service Output method
Similar to the hour output method, this method based
its computation on how much the asset has been
used.
𝐐𝐚
𝐝𝐚 = (𝐕 − 𝐕𝐬 ) 𝐕𝐚 = 𝐕 − 𝐝𝐚
𝐐

Where:
Q = total amount that the asset can give service
Qa = amount of the asset has been used
 Sample Problems on
Service and Hour Output Method
1. An electric bulb bought for Php100 is guaranteed to be
useful for 50 hours. A certain company uses the said
bulb for 10 hours a day. If there is no scrap value for the
bulb. Compute the daily depreciation and create the
depreciation table throughout its economic life.
2. A tire bought for Php1,000 is expected to be useful in
traveling 100 km after which it can be sold as scrap for
Php50. (a) If the pedometer displays a value of 85 km,
what is the book value of the tire? (b) How much did the
owner need to travel for the tire to amount to Php80?
 Module 5
BREAK-EVEN ANALYSIS

Engr. Gerard Ang

School of EECE
 Definition of Terms
 Break-Even Analysis – it involves estimating the
level of sales necessary to operate a business on
a break-even basis.
 Break-Even Point (BEP) – is defined as the point
where sales or revenues equal total expenses.
 Break-Even Margin – is a ratio that shows the
gross-margin factor for a break-even condition.
The formula is total expenses divided by net
revenues multiplied by 100 to get a percentage.
 Break-Even Graph
Break-Even Chart – shows the graph of fixed cost,
variable cost and expected income from sales for
different production levels.
 Ways to Lower the
Break-Even Point
 Lower direct costs, which will raise the
gross margin.
 Exercise cost controls on your fixed
expenses, and lower the necessary
total expenses.
 Raise prices.
 Key Break-Even Factors
 Fixed Costs – these costs remain constant (or nearly so)
within the projected range of sales levels. These can include
facilities costs, certain general and administrative costs, and
interest and depreciation expenses.
 Variable Costs – these costs vary in proportion to sales
levels. They can include direct material and labor costs, the
variable part of manufacturing overhead, and transportation
and sales commission expenses.
 Contribution Margin – this is equal to sales revenues less
variable costs. This amount is available to offset fixed
expenses and (hopefully) produce an operating profit for the
business.
Appraisal of Break-Even Analysis
Advantages of Break-Even Analysis
 It points out the relationship between cost, production
volume and returns.

Limitations of Break-Even Analysis

 It is best suited to the analysis of one product at a time.
 It may be difficult to classify a cost as all variable or all
fixed.
 There may be a tendency to continue to use a break-even
analysis after the cost and income functions have
changed.
 Sample Problems on
Break Even Analysis
1. An entrepreneur at the location in the United States is
planning to enter the gourmet soy-based burger market.
The forecast expected unit sales of 200,000 burgers in 18
months. The variable cost for making one burger is $0.85
and the fixed cost of making burgers for 18 months will be
a total of $165,000 which covers for the rent, phone bill,
and insurance coverage – these items tend not to vary in
amount per month over the term of one year. The best
estimate of what the average consumer will pay for the soy
burger is $1.95. How many burgers will he have to sell to
break even?
 Sample Problems on
Break Even Analysis
2. Toyota Motor Phils. Corporation Sta. Rosa Plant has
a production capacity of 700 cars per month and its
fixed cost is Php100,000,000 monthly. The variable
cost per car is Php300,000 and each car can be sold
for Php650,000. Due to cost reduction program, fixed
cost will be reduced to 10% and variable cost by 20%.
Determine the new and old break break-even point.
 Sample Problems on
Break Even Analysis
3. A farmer wants to buy a new combine rather than hire
a custom harvester. The total fixed costs for the
desired combine are $21,270 per year. The variable
cost (not counting the operator’s labor) are $8.75 per
hour. The farmer can harvest 5 acres per hour. The
custom harvester charges $16.00 per acre. How
many acres must be harvested per year to
break-even?
 Module 5
BREAK-EVEN ANALYSIS

Engr. Gerard Ang

School of EECE
 Definition of Terms
 Break-Even Analysis – it involves estimating the
level of sales necessary to operate a business on
a break-even basis.
 Break-Even Point (BEP) – is defined as the point
where sales or revenues equal total expenses.
 Break-Even Margin – is a ratio that shows the
gross-margin factor for a break-even condition.
The formula is total expenses divided by net
revenues multiplied by 100 to get a percentage.
 Break-Even Graph
Break-Even Chart – shows the graph of fixed cost,
variable cost and expected income from sales for
different production levels.
 Ways to Lower the
Break-Even Point
 Lower direct costs, which will raise the
gross margin.
 Exercise cost controls on your fixed
expenses, and lower the necessary
total expenses.
 Raise prices.
 Key Break-Even Factors
 Fixed Costs – these costs remain constant (or nearly so)
within the projected range of sales levels. These can include
facilities costs, certain general and administrative costs, and
interest and depreciation expenses.
 Variable Costs – these costs vary in proportion to sales
levels. They can include direct material and labor costs, the
variable part of manufacturing overhead, and transportation
and sales commission expenses.
 Contribution Margin – this is equal to sales revenues less
variable costs. This amount is available to offset fixed
expenses and (hopefully) produce an operating profit for the
business.
Appraisal of Break-Even Analysis
Advantages of Break-Even Analysis
 It points out the relationship between cost, production
volume and returns.

Limitations of Break-Even Analysis

 It is best suited to the analysis of one product at a time.
 It may be difficult to classify a cost as all variable or all
fixed.
 There may be a tendency to continue to use a break-even
analysis after the cost and income functions have
changed.
 Sample Problems on
Break Even Analysis
1. An entrepreneur at the location in the United States is
planning to enter the gourmet soy-based burger market.
The forecast expected unit sales of 200,000 burgers in 18
months. The variable cost for making one burger is $0.85
and the fixed cost of making burgers for 18 months will be
a total of $165,000 which covers for the rent, phone bill,
and insurance coverage – these items tend not to vary in
amount per month over the term of one year. The best
estimate of what the average consumer will pay for the soy
burger is $1.95. How many burgers will he have to sell to
break even?
 Sample Problems on
Break Even Analysis
2. Toyota Motor Phils. Corporation Sta. Rosa Plant has
a production capacity of 700 cars per month and its
fixed cost is Php100,000,000 monthly. The variable
cost per car is Php300,000 and each car can be sold
for Php650,000. Due to cost reduction program, fixed
cost will be reduced to 10% and variable cost by 20%.
Determine the new and old break break-even point.
 Sample Problems on
Break Even Analysis
3. A farmer wants to buy a new combine rather than hire
a custom harvester. The total fixed costs for the
desired combine are $21,270 per year. The variable
cost (not counting the operator’s labor) are $8.75 per
hour. The farmer can harvest 5 acres per hour. The
custom harvester charges $16.00 per acre. How
many acres must be harvested per year to
break-even?
 Module 6
COMPARISON OF
ALTERNATIVES

Engr. Gerard Ang

School of EECE
 Definition of Terms
1. Comparison of Alternatives – deals with situations in which one
has more than one choice and using engineering economic
principles, one needs to decide between the alternatives so as
to go with the one that is most economically justified.

2. Methods used in the Selection of Alternatives

 Present Worth Method
 Annual Cost/Worth Method
 Equivalent Uniform Annual Cost (EUAC) Method
 Rate of Return (ROR) Method
 Payback (Payout) Period Method
 Capitalized Cost
 Benefit/Cost Ratio Analysis
 Present Worth Method
This method involves finding the equivalent value of each
alternative at the present time, identified as time 0. If only
costs are involved, we can select the alternative with the
smallest present worth of costs. If cost and revenues are
involved, we select the alternative with the greatest present
worth on net revenues.
To perform present worth or annual worth analysis, an
interest rate and a study period must be specified. The
interest rate is usually the minimum acceptable rate of return
(MARR) of the organization.
 Present Worth Method
Present worth analysis can only be used when the
alternatives have the same lives. If the alternatives have
different lives, some mechanism must be used to compare
them over the common study period.
Total Present Worth = P1 + P2 + P3

Where: P1 = initial investment

P2 = present worth of annuity of annual cost
P3 = present worth of some receipts

𝟏 − (𝟏 + 𝐢)−𝐧
𝐏𝟐 = 𝐀 𝐏𝟑 = 𝐅(𝟏 + 𝐢)−𝐧
𝐢
 Sample Problems on
Present Worth Method
1. Motors from two different manufacturers are being
considered for application. Both motors are 50
HP, 460 volts, 3-phase, 60 Hz, but motor A operates at
80% efficiency whereas motor B operates at 88%
efficiency. The expected used for motors are 20 years.
Motor A costs Php600,000 and motor B costs
Php750,000. Electrical energy cost Php3.00 per kW-hr
and the motors will be operated at 8 hours per day,
250 days per year. Assume taxes are 5% and rate of
interest is 10%. Which motor is purchased? Also, life of
both motors is 15 years.
 Sample Problems on
Present Worth Method
1. Motors from two different manufacturers are being considered for application. Both
motors are 50 HP, 460 volts, 3-phase, 60 Hz, but motor A operates at 80%
efficiency whereas motor B operates at 88% efficiency. The expected used for
motors are 20 years. Motor A costs Php600,000 and motor B costs Php750,000.
Electrical energy cost Php3.00 per kW-hr and the motors will be operated at 8 hours
per day, 250 days per year. Assume taxes are 5% and rate of interest is 10%. Which
motor is purchased? Also, life of both motors is 15 years.

Factor Considered Motor A Motor B

Initial Investment (P1) 600,000.00 750,000.00
Annual Expenses
Energy Expenses 279,750.00 254,318.18
Taxes 30,000.00 37,500.00
Total Annual Expenses 309,750.00 291,818.18
P2 = 2,355,983.13 2,219,592.29
P3 = 0.00 0.00
Total Present Worth 2,955,983.13 2,969,592.29
Since PW of motor A < PW of motor B, select motor A
 Sample Problems on
Present Worth Method
2. Perform a present worth analysis of equal service
machines with the costs shown below, if the MARR is
10% per year. Revenues for all three alternatives are
expected to be the same.

Electric Gas Solar

Powered Powered Powered
First Cost, $ 2,500 3,500 6,000
Annual Operating 900 700 50
Cost, $
Salvage Value, $ 200 350 100
Life, years 5 5 5
 Sample Problems on
Present Worth Method
2. Perform a present worth analysis of equal service machines with the costs shown
below, if the MARR is 10% per year. Revenues for all three alternatives are
expected to be the same.
Electric Powered Gas Powered Solar Powered
First Cost, $ 2,500 3,500 6,000
Annual Operating Cost, $ 900 700 50
Salvage Value, $ 200 350 100
Life, years 5 5 5

Electric Gas Solar

P1 2,500.00 3,500.00 6,000.00
P2 3,411.71 2,653.55 189.54
P3 124.18 217.32 62.09
Total 5,787.52 5,936.23 6,127.45
select electric powered because it has the smallest
present worth among the three alternatives
 Sample Problems on
Present Worth Method
3. A project engineer with EnvironCare is assigned to start up a new
office in a city where a 6 year contract has been finalized to take
and analyze ozone-level readings. Two lease options are
available, each with a first cost annual lease cost, and deposit-
return estimates shown below. Rate of interest is 15%.

Location A Location B
First Cost, $ 15,000 18,000
Annual Lease Cost, $ 3,500 3,100
Deposit Return, $ 1,000 2,000
Lease Term, years 6 9
 Sample Problems on
Present Worth Method
3. A project engineer with EnvironCare is assigned to start up a new office in a city where a
6 year contract has been finalized to take and analyze ozone-level readings. Two lease
options are available, each with a first cost annual lease cost, and deposit-return
estimates shown below. Rate of interest is 15%.
Location A Location B
First Cost, $ 15,000 18,000
Annual Lease Cost, $ 3,500 3,100
Deposit Return, $ 1,000 2,000
Lease Term, years 6 9

Location A Location B
P1 15,000.00 18,000.00
P2 21,447.88 18,996.69
P3 700.04 730.14
P4 9,288.52 5,116.72
Total 45,036.36 41,383.28
Select location B
 Annual Cost (Worth) Method
The annual worth method involves finding the equivalent
end-of-period value of each alternative. The periods are
usually in years. If only costs are involved, we can select
the alternative with the smallest equivalent uniform
annual cost (EUAC) or net annual cost (NAC). If costs
and revenues are involved, we can select the alternative
with the greatest equivalent uniform annual benefit, or
net annual worth (NAW).
If two alternatives have the same annual worth,
then the one with the greatest investment is preferred.
The extra investment makes exactly the required MARR.
 Annual Cost (Worth) Method
Problems that can be solved by the present worth method can also
be solved by the annual worth method. An annual worth analysis is
sometimes preferred over a present worth analysis because people
think better in terms of annual amounts than an equivalent amount to
time zero. Both methods yield the same results.
Annual worth analysis is the easiest method when the alternatives
have different lives. No specific study period need be specified, but the
implicit assumption that the alternative are compared over the least
common multiple of the lives.

Total Annual Worth = A1 + A2

Where: A1 = annual cost/income
A2 = annuity equivalent of the investment (depreciation)
𝐢
𝐀𝟐 = (𝐕 − 𝐕𝐬 )
(𝟏 + 𝐢)𝐧 −𝟏
 Sample Problems on
Annual Worth Method
1. Motors from two different manufacturers are being
considered for application. Both motors are 50
HP, 460 volts, 3-phase, 60 Hz, but motor A operates at
80% efficiency whereas motor B operates at 88%
efficiency. The expected used for motors are 20 years.
Motor A costs Php600,000 and motor B costs
Php750,000. Electrical energy cost Php3.00 per kW-hr
and the motors will be operated at 8 hours per day,
250 days per year. Assume taxes are 5% and rate of
interest is 10%. Which motor is purchased? Also, life of
both motors is 15 years.
 Sample Problems on
Annual Worth Method
1. Motors from two different manufacturers are being considered for application. Both
motors are 50 HP, 460 volts, 3-phase, 60 Hz, but motor A operates at 80%
efficiency whereas motor B operates at 88% efficiency. The expected used for
motors are 20 years. Motor A costs Php600,000 and motor B costs Php750,000.
Electrical energy cost Php3.00 per kW-hr and the motors will be operated at 8 hours
per day, 250 days per year. Assume taxes are 5% and rate of interest is 10%. Which
motor is purchased? Also, life of both motors is 15 years.

Factor Considered Motor A Motor B

Annual Expenses
Energy Consumption 279,750.00 254,318.18
Taxes 30,000.00 37,500.00
Interest on Capital 60,000.00 75,000.00
Total (A1) 369,750.00 366,818.18
Annual Depreciation (A2) 18,884.27 23,605.33
Total Annual Worth 388,634.27 390,423.51
Since AW of motor A < AW of motor B, select A
 Sample Problems on
Annual Worth Method
2. Perform an annual worth analysis of equal service
machines with the costs shown below, if the MARR is
10% per year. Revenues for all three alternatives are
expected to be the same.

Electric Gas Solar

Powered Powered Powered
First Cost, $ 2,500 3,500 6,000
Annual Operating 900 700 50
Cost, $
Salvage Value, $ 200 350 100
Life, years 5 5 5
 Sample Problems on
Annual Worth Method
2. Perform a present worth analysis of equal service machines with the costs shown
below, if the MARR is 10% per year. Revenues for all three alternatives are
expected to be the same.
Electric Powered Gas Powered Solar Powered
First Cost, $ 2,500 3,500 6,000
Annual Operating Cost, $ 900 700 50
Salvage Value, $ 200 350 100
Life, years 5 5 5

Electric Gas Solar

Annual Expenses
AOC 900.00 700.00 50.00
Interest on Capital 250.00 350.00 600.00
Total Annual Expenses (A1) 1,150.00 1,050.00 650.00
Annual Depreciation (A2) 376.73 515.96 966.41
Total Annual Worth 1,526.73 1,565.96 1,616.41
Select electric since it has the smallest AW among the three
 Sample Problems on
Annual Worth Method
3. A project engineer with EnvironCare is assigned to start
up a new office in a city where a 6 year contract has
been finalized to take and analyze ozone-level readings.
Two lease options are available, each with a first cost
annual lease cost, and deposit-return estimates shown
below. Rate of interest is 15%.

Location A Location B
First Cost, $ 15,000 18,000
Annual Lease Cost, $ 3,500 3,100
Deposit Return, $ 1,000 2,000
Lease Term, years 6 9
 Sample Problems on
Annual Worth Method
3. A project engineer with EnvironCare is assigned to start up a new office in a city where a
6 year contract has been finalized to take and analyze ozone-level readings. Two lease
options are available, each with a first cost annual lease cost, and deposit-return
estimates shown below. Rate of interest is 15%.

Location A Location B
First Cost, $ 15,000 18,000
Annual Lease Cost, $ 3,500 3,100
Deposit Return, $ 1,000 2,000
Lease Term, years 6 9

Location A Location B
Annual Expenses
Lease Cost 3,500.00 3,100.00
Interest on Capital 2,250.00 2,700.00
Total Expenses (A1) 5,750.00 5,800.00
Annual Depreciation (A2) 1,713.55 1,072.33
Total Annual Worth 7,463.55 6,872.33
Select location B
 Equivalent Uniform
Annual Cost (EUAC) Method
In this method, all cash flow (irregular or uniform)
must be converted to an equivalent uniform annual
cost, that is, a year-end amount which is the same
each year. The alternative with the least EUAC is
preferred. When the EUAC method is used, the
EUAC of the alternatives must be calculated for one
life cycle only. This method is flexible and can be
used for any type of alternative selection problems.
The method is a modification of the annual cost
method.
 Sample Problems on
Equiv. Uniform Annual Cost Method
1. Motors from two different manufacturers are being
considered for application. Both motors are 50
HP, 460 volts, 3-phase, 60 Hz, but motor A operates at
80% efficiency whereas motor B operates at 88%
efficiency. The expected used for motors are 20 years.
Motor A costs Php600,000 and motor B costs
Php750,000. Electrical energy cost Php3.00 per kW-hr
and the motors will be operated at 8 hours per day,
250 days per year. Assume taxes are 5% and rate of
interest is 10%. Which motor is purchased? Also, life of
both motors is 15 years.
 Sample Problems on
Equiv. Uniform Annual Cost Method
1. Motors from two different manufacturers are being considered for application. Both
motors are 50 HP, 460 volts, 3-phase, 60 Hz, but motor A operates at 80%
efficiency whereas motor B operates at 88% efficiency. The expected used for
motors are 20 years. Motor A costs Php600,000 and motor B costs Php750,000.
Electrical energy cost Php3.00 per kW-hr and the motors will be operated at 8 hours
per day, 250 days per year. Assume taxes are 5% and rate of interest is 10%. Which
motor is purchased? Also, life of both motors is 15 years.

Motor A Motor B
Annual Equiv Equal Amt 78,884.27 98,605.33
Annual Expenses
Energy Consumption 279,750.00 254,318.18
Taxes 30,000.00 37,500.00
Total Annual Expenses 309,750.00 291,818.18
Total EUAC 388,634.27 390,423.51
Since EUAC of motor A < EUAC of motor B, select motor A
 Sample Problems on
Equiv. Uniform Annual Cost Method
2. Perform an equivalent uniform annual cost analysis of
equal service machines with the costs shown below, if
the MARR is 10% per year. Revenues for all three
alternatives are expected to be the same.

Electric Gas Solar

Powered Powered Powered
First Cost, $ 2,500 3,500 6,000
Annual Operating 900 700 50
Cost, $
Salvage Value, $ 200 350 100
Life, years 5 5 5
 Sample Problems on
Equiv. Uniform Annual Cost Method
2. Perform a present worth analysis of equal service machines with the costs shown
below, if the MARR is 10% per year. Revenues for all three alternatives are
expected to be the same.

Electric Powered Gas Powered Solar Powered

First Cost, $ 2,500 3,500 6,000
Annual Operating Cost, $ 900 700 50
Salvage Value, $ 200 350 100
Life, years 5 5 5

Electric Gas Solar

Annual Equiv Equal Amt 659.49 923.29 1,582.78
Annual Expenses
AOC 900.00 700.00 50.00
Total EUAC 1,559.49 1,623.29 1,632.78
Select Electric
 Sample Problems on
Equiv. Uniform Annual Cost Method
3. A project engineer with EnvironCare is assigned to start
up a new office in a city where a 6 year contract has
been finalized to take and analyze ozone-level readings.
Two lease options are available, each with a first cost
annual lease cost, and deposit-return estimates shown
below. Rate of interest is 15%.

Location A Location B
First Cost, $ 15,000 18,000
Annual Lease Cost, $ 3,500 3,100
Deposit Return, $ 1,000 2,000
Lease Term, years 6 9
 Sample Problems on
Equiv. Uniform Annual Cost Method
3. A project engineer with EnvironCare is assigned to start up a new office in a city where a
6 year contract has been finalized to take and analyze ozone-level readings. Two lease
options are available, each with a first cost annual lease cost, and deposit-return
estimates shown below. Rate of interest is 15%.
Location A Location B
First Cost, $ 15,000 18,000
Annual Lease Cost, $ 3,500 3,100
Deposit Return, $ 1,000 2,000
Lease Term, years 6 9

Location A Location B
Annual Equiv Annual Amt 3,963.55 3,772.33
Total Annual Expenses 3,500.00 3,100.00
Total EUAC 7,463.55 6,872.33
Select location B
Rate of Return (ROR) Method
Rate of Return (ROR) – is the rate paid on the unpaid balance
of borrowed money or the rate earned on the uncovered
balanced of an investment. It is also called as internal rate of
return (IRR), return on investment (ROI) and profitability index
(PI).

𝐚𝐧𝐧𝐮𝐚𝐥 𝐧𝐞𝐭 𝐬𝐚𝐯𝐢𝐧𝐠𝐬

𝐑𝐎𝐑 =
𝐚𝐝𝐝𝐢𝐭𝐢𝐨𝐧𝐚𝐥 𝐢𝐧𝐯𝐞𝐬𝐭𝐦𝐞𝐧𝐭

If
ROR > MARR, select the alternative with the bigger investment
ROR < MARR, select the alternative with the smaller investment
Rate of Return (ROR) Method

The rate of return on the capital invested is

𝐧𝐞𝐭 𝐜𝐚𝐩𝐢𝐭𝐚𝐥 𝐩𝐫𝐨𝐟𝐢𝐭

𝐑𝐎𝐑 =
𝐜𝐚𝐩𝐢𝐭𝐚𝐥 𝐢𝐧𝐯𝐞𝐬𝐭𝐞𝐝

If ROR > MARR, then investment is profitable

If ROR < MARR, then investment is unprofitable
 Sample Problems on
Rate of Return Method
1. Motors from two different manufacturers are being
considered for application. Both motors are 50
HP, 460 volts, 3-phase, 60 Hz, but motor A operates at
80% efficiency whereas motor B operates at 88%
efficiency. The expected used for motors are 20 years.
Motor A costs Php600,000 and motor B costs
Php750,000. Electrical energy cost Php3.00 per kW-hr
and the motors will be operated at 8 hours per day,
250 days per year. Assume taxes are 5% and rate of
interest is 10%. Which motor is purchased? Also, life of
both motors is 15 years.
 Sample Problems on
Rate of Return Method
1. Motors from two different manufacturers are being considered for application. Both
motors are 50 HP, 460 volts, 3-phase, 60 Hz, but motor A operates at 80%
efficiency whereas motor B operates at 88% efficiency. The expected used for
motors are 20 years. Motor A costs Php600,000 and motor B costs Php750,000.
Electrical energy cost Php3.00 per kW-hr and the motors will be operated at 8 hours
per day, 250 days per year. Assume taxes are 5% and rate of interest is 10%. Which
motor is purchased? Also, life of both motors is 15 years.

Motor A Motor B
Annual Expenses
Energy Consumption 279,750.00 254,318.18
Taxes 30,000.00 37,500.00
Total Annual Expenses (A1) 309,750.00 291,818.18
Annual Depreciation (A2) 18,884.27 23,605.33
Total 328,634.27 315,423.51
Initial Investment 600,000.00 750,000.00
Annual Net Savings 13,210.75
Additional Investment 150,000.00
ROR = 8.81%
MARR = 10.00%
Since ROR < MARR, select motor A (smaller investment)
 Sample Problems on
Rate of Return Method
2. Perform an annual worth analysis of equal service
machines with the costs shown below, if the MARR is
10% per year. Revenues for all three alternatives are
expected to be the same.

Electric Gas Solar

Powered Powered Powered
First Cost, $ 2,500 3,500 6,000
Annual Operating 900 700 50
Cost, $
Salvage Value, $ 200 350 100
Life, years 5 5 5
 Sample Problems on
Rate of Return Method
2. Perform a present worth analysis of equal service machines with the costs shown
below, if the MARR is 10% per year. Revenues for all three alternatives are
expected to be the same.
Electric Powered Gas Powered Solar Powered
First Cost, $ 2,500 3,500 6,000
Annual Operating Cost, $ 900 700 50
Salvage Value, $ 200 350 100
Life, years 5 5 5

Electric Gas
Total Annual Expenses 900.00 700.00
Annual Depreciation 376.73 515.96
Total 1,276.73 1,215.96
Initial Investment 2,500.00 3,500.00
Annual Net Savings 60.77
Additional Investment 1,000.00
ROR = 6.08%
MARR = 10.00%
select electric
 Sample Problems on
Rate of Return Method
2. Perform a present worth analysis of equal service machines with the costs shown
below, if the MARR is 10% per year. Revenues for all three alternatives are
expected to be the same.
Electric Powered Gas Powered Solar Powered
First Cost, $ 2,500 3,500 6,000
Annual Operating Cost, $ 900 700 50
Salvage Value, $ 200 350 100
Life, years 5 5 5

Electric Solar
Total Annual Expenses 900.00 50.00
Annual Depreciation 376.73 966.41
Total 1,276.73 1,016.41
Initial Investment 2,500.00 6,000.00
Annual Net Savings 260.33 1,016.41
Additional Investment 3,500.00
ROR = 7.44%
MARR = 10.00%
finally select electric powered
 Sample Problems on
Rate of Return Method
3. A project engineer with EnvironCare is assigned to start
up a new office in a city where a 6 year contract has
been finalized to take and analyze ozone-level readings.
Two lease options are available, each with a first cost
annual lease cost, and deposit-return estimates shown
below. Rate of interest is 15%.

Location A Location B
First Cost, $ 15,000 18,000
Annual Lease Cost, $ 3,500 3,100
Deposit Return, $ 1,000 2,000
Lease Term, years 6 9
 Sample Problems on
Rate of Return Method
3. A project engineer with EnvironCare is assigned to start up a new office in a city where a
6 year contract has been finalized to take and analyze ozone-level readings. Two lease
options are available, each with a first cost annual lease cost, and deposit-return
estimates shown below. Rate of interest is 15%.
Location A Location B
First Cost, $ 15,000 18,000
Annual Lease Cost, $ 3,500 3,100
Deposit Return, $ 1,000 2,000
Lease Term, years 6 9

Location A Location B
Total Annual Expenses 3,500.00 3,100.00
Annual Depreciation 1,713.55 1,072.33
Total 5,213.55 4,172.33
Initial Investment 15,000.00 18,000.00
Annual Net Savings 1,041.22
Additional Investment 3,000.00
ROR = 34.71%
MARR = 10.00%
Since ROR > MARR, select location B (bigger investment)
 Sample Problems on
Rate of Return Method

4. A firm is considering purchasing equipment that will

reduce costs by Php40,000. The equipment costs
Php300,000 and has a salvage value of Php50,000
and a life of 7 years. The annual maintenance cost is
Php6,000. While not used by the firm, the equipment
can be rented to others to generate an income of
Php10,000 per year. If money can be invested for an
8% return, is the firm justified in buying the
equipment?
 Sample Problems on
Rate of Return Method
4. A firm is considering purchasing equipment that will reduce costs by Php40,000. The
equipment costs Php300,000 and has a salvage value of Php50,000 and a life of 7 years.
The annual maintenance cost is Php6,000. While not used by the firm, the equipment can
be rented to others to generate an income of Php10,000 per year. If money can be
invested for an 8% return, is the firm justified in buying the equipment?

Gross Capital Profit

Annual Rental 10,000.00
Annual Savings 40,000.00
Total Gross Capital Profit 50,000.00
Annual Expenses
Annual Maintenance 6,000.00
Depreciation 28,018.10
Total Annual Expenses 34,018.10
Initial Investment 300,000.00
MARR 8%
Net Capital Profit 15,981.90
ROR = 5.33%
Since, ROR< MARR do not buy the new eqpt
 Payback (Payout) Period Method
In this method, the payback period of each alternative
is computed. The alternative with shortest payback period
is adopted. This method is seldom used.

Payback Period – is the length of time required to recover

the first cost of an investment from the net cash flow
produced by that investment for an interest rate of zero.

𝐜𝐚𝐩𝐢𝐭𝐚𝐥 𝐢𝐧𝐯𝐞𝐬𝐭𝐞𝐝
𝐏𝐚𝐲𝐛𝐚𝐜𝐤 𝐏𝐞𝐫𝐢𝐨𝐝 =
𝐧𝐞𝐭 𝐚𝐧𝐧𝐮𝐚𝐥 𝐩𝐫𝐨𝐟𝐢𝐭
 Sample Problem on
Payback Period Method
In a marble block quarrying operation, hand rock drills, costing
Php50,000 each, are used. It has a drilling rate of 10 cm per minute,
produces 10 cubic meters of block per month and consumes 60 liters of
diesel fuel for compressor drive, per rock drill per cubic meter produced
utilizing 1 worker per drill.
A modern equipment quarry bar mounted rock drill is being offered
for Php180,000 per unit and has a drilling rate of 60 per minute that will
produce 60 cubic meters of block per month, but consumes 120 liters of
diesel fuel for the compressor drive, per 6 cubic meters of block
utilized, utilizing 2 workers per quarry bar drill.
Consider diesel fuel at Php6.00 per liter at the quarries, worker
earning Php80.00 per day, 25 days per month, 5 years life of both drills
with 20% salvage value, neglecting cost of money, other cost at
Php500 per cubic meter and marble blocks sold at Php2,000 per cubic
meter. Would you recommend the purchase of the new equipment?
 Sample Problem on
Payback Period Method
In a marble block quarrying operation, hand rock drills, costing Php50,000 each, are used. It has a
drilling rate of 10 cm per minute, produces 10 cubic meters of block per month and consumes 60 liters of
diesel fuel for compressor drive, per rock drill per cubic meter produced utilizing 1 worker per drill.
A modern equipment quarry bar mounted rock drill is being offered for Php180,000 per unit and has a
drilling rate of 60 per minute that will produce 60 cubic meters of block per month, but consumes 120 liters of
diesel fuel for the compressor drive, per 6 cubic meters of block utilized, utilizing 2 workers per quarry bar
drill.
Consider diesel fuel at Php6.00 per liter at the quarries, worker earning Php80.00 per day, 25 days per
month, 5 years life of both drills with 20% salvage value, neglecting cost of money, other cost at Php500 per
cubic meter and marble blocks sold at Php2,000 per cubic meter. Would you recommend the purchase of the
new equipment?
hand rock drill mounted rock drill
Capital Investement 50,000.00 180,000.00
Gross Annual Profit
Annual Income 240,000.00 1,440,000.00
Annual Expenses
Annual Fuel Cost 43,200.00 86,400.00
Annual Salary 24,000.00 48,000.00
Annual Depreciation 8,000.00 28,800.00
Other Cost 60,000.00 360,000.00
Total Annual Expenses 135,200.00 523,200.00
Net Annual Profit 104,800.00 916,800.00
Payback Period (years) 0.477 0.196
Since payback period of mounted rock drill < payback period of
hand rock drill, purchase the mounted rock drill
 Capitalized Cost
Capitalized Cost – is the present worth of an
alternative that will last “forever.” Public sector
projects such as bridges, dams, irrigation systems
and railroad fall into this category.

𝐕 − 𝐕𝐬 𝐀𝐎𝐂
𝐂𝐂 = 𝐕 + +
(𝟏 + 𝐢)𝐧 −𝟏 𝐢

Where:
CC = capitalized cost
AOC = annual operating cost
 Sample Problems on
Capitalized Cost
Two methods of conveying eater are being studied.
Method A requires a tunnel, first cost Php180,000, life
perpetual, annual operation and upkeep is Php3,000.
Method B requires a ditch plus flume; first cost of ditch is
Php40,000, life perpetual, annual depreciation and
upkeep is Php1,500, first cost of flume is Php30,000, life
10 years, salvage value is Php5,000, annual operation
and upkeep is Php4,000. If money is worth 6%,
determine which method is to be recommended?
 Sample Problems on
Capitalized Cost
Two methods of conveying eater are being studied. Method A requires a tunnel, first
cost Php180,000, life perpetual, annual operation and upkeep is Php3,000. Method
B requires a ditch plus flume; first cost of ditch is Php40,000, life perpetual, annual
depreciation and upkeep is Php1,500, first cost of flume is Php30,000, life 10 years,
salvage value is Php5,000, annual operation and upkeep is Php4,000. If money is
worth 6%, determine which method is to be recommended?

method A method B
tunnel ditch flume
First Cost 180,000.00 40,000.00 30,000.00
Annual Depreciation 0.00 0.00 31,611.65
Perpetuity 50,000.00 25,000.00 66,666.67
Total 230,000.00 65,000.00 128,278.32
Method A 230,000.00
Method B 193,278.32
Select method B
 Benefit/Cost Ratio Analysis
Benefit/Cost Ratio Analysis – it is the most commonly
used method by government agencies for analyzing the
desirability of public projects.

𝐛𝐞𝐧𝐞𝐟𝐢𝐭𝐬 − 𝐝𝐢𝐬𝐛𝐞𝐧𝐞𝐟𝐢𝐭𝐬
𝐁/𝐂 =
𝐜𝐨𝐬𝐭𝐬

If B/C ≥ 1.0, accept the project as economically

acceptable for the estimates and discount rate
applicable.
 Benefit/Cost Ratio Analysis
 Cost – estimated expenditures to the government
entity for construction, operation, and maintenance of
the project less any expected salvage value.

 Benefits – advantages to be experienced by the

owners, the public.

 Disbenefits – expected undesirable or negative

consequences to the owners if the alternative is
implemented. Disbenefits may be indirect economic
disadvantages of the alternative.
 Benefit/Cost Ratio Analysis

The benefit cost ratio on the capital invested is

𝒊𝒏𝒄𝒓𝒆𝒎𝒆𝒏𝒕𝒂𝒍 𝒃𝒆𝒏𝒆𝒇𝒊𝒕
𝑩/𝑪 =
𝒊𝒏𝒄𝒓𝒆𝒎𝒆𝒏𝒕𝒂𝒍 𝒄𝒐𝒔𝒕

If B/C < 1, select the alternative with the lower

investment/initial cost
If B/C > 1, select the alternative with the higher
investment/initial cost
 Significant Differences in the Characteristics
of Public and Private Sector Alternatives
Characteristic Public Sector Private Sector
Some large; more medium to
Size of Investment Larger
small

Life Estimates Longer (30 – 50+ years) Shorter (2 – 25 years)

Annual Cash Flow

Estimates No profit; costs, benefits and Revenues contribute to profits;
disbenefits are estimated costs are estimated

Taxes, fee, bonds, private Stocks, bonds, loans, individual

Funding
funds owners

Higher, based on market cost of

Interest Rate Lower
capital

Alternative Selection
Multiple criteria Primarily based on rate of return
Criteria
Environment of the
Politically inclined Primarily economic
Evaluation
 Sample Problems on
Benefit/Cost Ratio Analysis
1. The National Government intends to build a dam
and hydroelectric project in the Cagayan Valley at
a total cost of Php455,500,000. The project will be
financed by soft foreign loan with an interest of 5%
per year. The annual cost for operation,
maintenance, distribution, facilities and others
would total Php15,100,000. Annual revenues
and benefits are estimated to be Php56,500,000.
If the structures are expected to last for 50
years with no salvage value, is the project
economically acceptable?
 Sample Problems on
Benefit/Cost Ratio Analysis
1. The National Government intends to build a dam and hydroelectric
project in the Cagayan Valley at a total cost of Php455,500,000. The
project will be financed by soft foreign loan with an interest of 5% per year.
The annual cost for operation, maintenance, distribution, facilities and
others would total Php15,100,000. Annual revenues and benefits are
estimated to be Php56,500,000.
If the structures are expected to last for 50 years with no salvage
value, is the project economically acceptable?

Annual Costs (using EUAC method)

Annual Operating
Cost 15,100,000.00
Annuity 24,950,803.01
Total Annual Cost 40,050,803.01
Benefits 56,500,000.00
Disbenefits 0.00
B/C = 1.41
since B/C > 1, the project is economically feasible
 Sample Problems on
Benefit/Cost Ratio Analysis
2. Two routes are under construction for a new highway. Route A would
be located about 5 miles from the central business district and would
require longer travel distances by local commuter traffic. Route B would
pass directly through the downtown area and although its
construction cost would be higher, it would reduce the travel time
and distance for local commuters. The costs for the two roads are as
follows:
Route A Route B
Initial Cost, Php 200,000,000 250,000,000
Maintenance per year. Php 700,000 1,100,000
Road user cost per year, Php 10,000,000 4,000,000

If the roads are assumed to last for 30 years with no salvage value, which
route should be accepted on the basis of a benefit/cost ratio analysis
using an interest rate of 15%.
 Sample Problems on
Benefit/Cost Ratio Analysis
2. Two routes are under Route A Route B
construction for a new
Initial Cost, Php 200,000,000 250,000,000
highway. Route A would be
located about 5 miles from the Maintenance per year. Php 700,000 1,100,000
central business district and Road user cost per year, Php 10,000,000 4,000,000
would require longer travel
distances by local commuter
traffic. Route B would pass If the roads are assumed to last for 30 years with no
directly through the downtown salvage value, which route should be accepted on the
area and although its basis of a benefit/cost ratio analysis using an interest
construction cost would be rate of 15%.
higher, it would reduce the Route A Route B
travel time and distance for Inital Cost 200,000,000.00 250,000,000.00
local commuters. The costs for Annual Costs (using EUAC
the two roads are as method)
Annual Maintenance 700,000.00 1,100,000.00
follows:
Annuity 30,460,039.64 38,075,049.55
Total Annual Costs 31,160,039.64 39,175,049.55
Benefits 10,000,000.00 4,000,000.00
Incremental Benefit 6,000,000.00
Incremental Cost 8,015,009.91
B/C 0.75
Since B/C< 1, select route route A
 Sample Problems on
Benefit/Cost Ratio Analysis
3. Four alternatives for providing electric power
supply to a small town have been identified with
the following annual benefits and costs:

Annual Benefits Annual Costs

Alternative
(Php) (Php)
A 1,528,000 780,000
B 1,398,000 664,000
C 960,000 742,000
D 810,000 420,000
 Sample Problems on
Benefit/Cost Ratio Analysis
3. Four alternatives for providing electric power supply to a small town have been
identified with the following annual benefits and costs:

Alternative Annual Benefits (Php) Annual Costs (Php)

A 1,528,000 780,000
B 1,398,000 664,000
C 960,000 742,000
D 810,000 420,000

A B C D
Annual Cost 780,000.00 664,000.00 742,000.00 420,000.00
Annual Benefits 1,528,000.00 1,398,000.00 960,000.00 810,000.00
Between A and B
B/C 1.12select A
Between C and D
B/C 0.47select D
Finally, between A and D
B/C 1.99select A
 Module 7
CAPITAL FINANCING

Engr. Gerard Ang

School of EECE
 Equity and Borrowed Capital
 Equity Capital or Ownership Forms – are
those supplied and used by the owners of an
enterprise in the expectation that profit will be
earned.

 Borrowed Funds or Capital – are those

supplied by others on which a fixed rate of
interest must be paid at a specified time.
 Types of Business Ownership
 Individual Ownership or Sole Proprietorship – is one
which is owned and run by one individual and where there is
no legal distinction between the owner and the business.

 Partnership – is an association of two or more persons for

the purpose of engaging in business for a profit.

 Corporation – is a fictitious being, recognized by law, that

can engage in almost any type of business transaction in
which a real person could occupy himself. It operates under
a charter that is granted by the government.
 Advantages and Disadvantages
of Sole Proprietorship
Advantages:
 It is easy to organize.
 The owner has full control of the enterprise.
 The owner is entitled to whatever benefits and profits that accrue from
the business.
 It is easy to dissolve.

Disadvantages:
 The amount of equity capital which can be accumulated is limited.
 The organization ceases upon the death of the owner.
 It is difficult to obtain borrowed capital owing to the uncertainty of the
life of the organization.
 The liability of the owner for his debts are unlimited.
 Advantages and Disadvantages
of Partnership
Advantages:
 More capital may be obtained by the partners pooling their resources together.
 It is bound by few legal requirements as to its accounts, procedures, tax forms
and other items.
 Dissolution of a partnership may take place at any time by mere agreement of
the partners.
 It provides an easy method whereby two or more persons may enter into
business each carrying those burdens that he can best handle.

Disadvantages:
 The amount of capital that can be accumulated is definitely limited.
 The life of the partnership is determined by the life of the individual partners.
When any partner dies, the partnership automatically ends.
 There may be serious disagreement among individual partners.
 Each partner is liable for debts of the other partnership.
 Advantages and Disadvantages
of Corporation
Advantages:
 It enjoys perpetual life without regard to any change in the person of its
owners, the stockholders.
 The stockholders of the corporation are not liable for the debts of the
corporation.
 It is relatively easier to obtain large amounts of money for expansion due
to its perpetual life.
 The ownership in the corporation is readily transferred.
 Authority is easily delegated by the hiring of the managers.

Disadvantages:
 The activities of the corporation are limited to those stated in its charter.
 It is relatively complicated in formation and administration.
 There is greater degree of government control as compared to other types
of business organization.
 Capitalization of a Corporation
The capital of a corporation is acquired through the sale of stock. There
are two principal types of stock.

 Common Stock – represents ordinary ownership without special

guarantees of return.

 Preferred Stock – are guaranteed a definite dividend on their

stocks. In the case the corporation is dissolved, the assets must be
used to satisfy the claims of the preferred stockholders before
those of the common stockholders. Preferred stockholders usually
have the right to vote in meetings, but not always.
Rights of Common Stockholders

 Vote at stockholder’s meeting.

 Elect directors and delegates to them power to
conduct the affairs of the business.
 Sell or dissolve the corporation.
 Make and amend the by-laws of the corporation.
 Subject to government approval, amend or change
the charter or capital structure.
 Participate in profits.
 Inspect the book of the corporation.
 Financing of Bonds
 Bond – is a certificate of
indebtedness of a corporation
usually for a period of not less
than 10 years and guaranteed
by mortgage on certain assets
of the corporation or its
subsidiaries. Bonds are
issued when there is a need
for more capital such as for
expansion of the plant or the
services rendered by the
corporation.

 Face or Par Value of a Bond – is the amount stated on the bond.

When the face value has been repaid, the bond is said to have been
retired or redeemed. The bond rate is the interest rate quoted in the
bond.
 Classification of Bonds
According to the Method of Paying Interest:

 Registered Bond – the name of

the owner of this bond is recorded
on the record books of the
corporation and interest payments
are sent to the owner periodically
without any action.

 Coupon Bond – have coupon

attached to the bond for each
interest payment that will come due
during the life of the bond. The
owner of the bond can collect the
interest due by surrendering the
coupon to the offices of he
corporation or at specified banks.
 Classification of Bonds
According to the Security Behind the Bonds:
 Mortgage Bond – this is one of the most
common type of bonds. The security behind
these bonds is mortgage upon certain
specified assets of the corporation in the form
of a trust deed. If the corporation fails to pay
the value of the bond at the date of maturity,
title to the property is transferred to the
stockholders.

 Collateral Bond – the security behind this type

of bond is the stocks or bonds of a well-
established subsidiary of the corporation.

 Debenture Bond – a bond without any

security behind it except a promise to pay the
issuing corporation.
 Methods of Bond Retirement
 The corporation may issue another set of bonds
equal to the amount of bonds due for redemption.
 The corporation may set up a sinking fund into which
periodic deposits of equal amount are made. The
accumulated amount in the sinking fund is equal to
the amount needed to retire the bond at the time they
are due.
 The corporation may issue callable bonds. These
bonds permit repayment of the principal before
maturity.
 Value of a Bond
The value of a bond is the present worth of all future
amounts that are expected to be received through
ownership of the bond.

𝟏 − (𝟏 + 𝐢)−𝐧
𝐕𝐧 = 𝐂(𝟏 + 𝐢)−𝐧 +𝐅𝐫
𝐢

Where:
F = face or par value
C = redemption or disposal price (often equal to F)
r = bond rate per period
n = number of interest period
i = interest rate or yield per period
P = value of the bond in periods before redemption
 Sample Problems on Bonds
1. A 10 year corporate bond has a face value of
Php5,000 and a bond rate of 8% payable quarterly. A
prospective buyer desires to earn a nominal rate of
12% quarterly on investment. What purchase price
would the buyer be willing to pay? (php 4,573.49)

2. A bond with a par value of Php1,000 and with a bond

rate of 16% payable annually is sold now for
Php1,050. If the yield is to be 14%, how much should
be the redemption price at the end of seven years?
(Php 910.50)
 Sample Problems on Bonds
3. A bond issue of Php200,000 in 10 year bonds, Php1,000 units,
paying 16% nominal interest in semiannual payments, must be
retired by the use of a sinking fund that earns 12% compounded
semiannually. What is the total semiannual expense?

4. A man wants to make a 14% nominal interest compounded

semiannually on a bond investment. How much should the man be
willing to pay now for a 12% compounded semi-annually,
Php10,000 bond that will mature in 10 years and pays interest
semiannually? (Php 8,909.89)

5. A Php1,000 bond which will mature in 10 years and with a bond

rate of 8% payable annually is to be redeemed at par at the end of
this period. If it is sold at Php1,030, determine the yield at this
price. (7.56%)