SCHOOL OF ENGINEERING AND ARCHITECTURE

ECOENG1 ENGINEERING ECONOMICS I

Prepared by:
A Self-regulated Learning Module
Engr. Jasmin G. Madayag

A Self-regulated Learning Module 1

 TABLE OF CONTENTS TABLE OF CONTENTS

Course Description …...............................….……………………..................………….................................... 3

Activity Guidelines …….………………….................................…..................………….................................... 4

Study Schedule ...........................................................…….……………………..................………….............. 5

Lesson 1 – Introduction to Engineering Economics …….……………………..................…………............ 6 - 8

Lesson 2 – Selections on Present Economy …………………………………….................…………........… 9 - 12

Lesson 3 – Money-time Relationship …………………………………………….................…………........... 12 – 49

Lesson 4 – Depreciation …………………………………………………………................……………......... 50 – 59

Lesson 5 – Capital Financing ……………………………………………………................……….…........… 60 - 63

Lesson 6 – Basic Economy Study Methods …………………………………................………………......... 64 - 73

Lesson 7 – Decisions under Certainty ………………………………………..............……………….......... 74 - 93

Lesson 8 – Decisions Recognizing Risks ……………………………………..............………….........….... 94 - 98

Lesson 9 – Decisions Admitting Uncertainty …………………………………………………...................... 99 - 102

Lesson 10 – Basic Accounting Principles ………………………………………………….......................... 103 - 109

Course Evaluation, References .................................................................................................................. 110

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Course Code: ECOENG1

Course Title: Engineering Economics

Course Description:

Engineering economics is a three-unit course that deals with the analysis and evaluation of the best
use of capital in engineering projects and investment. The concept of money-time relationship and depreciation
will give the students an in-depth understanding in the value of an asset. The basic economy study methods
will help to evaluate alternatives for a certain investment as well as government projects. Decision analysis
models will be discussed to evaluate decision conditions under certainty, risk, and uncertainty. Lastly, the basic
accounting principles will help the future engineers to have knowledge in financial statement of engineering
firm.

Requirement of the Course:

The student is expected to punctually comply with class participation and submission of activities per
grading period. At the end of the semester, the students are expected to submit the following requirements;
a. Compiled activities of the course
b. Assessment of the course module
c. Evaluation of the course
d. Personal E-portfolio using google site with narrative report

Learning Outcome:
At the end of the course, the student shall be able to:
1. Describe the basic principle of engineering economics and apply it to related problems.
2. Apply the money-time relationship and depreciation analysis to tangible assets.
3. Use economy studies to evaluate the best alternatives for engineering problems.
4. Apply a rational decision-making to conditions certainty, risk, and uncertainty.
5. Identify costs component of financial statement in engineering firms.

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Activities and Rubrics
Quiz and Activity Format
Use short bond paper with half inch margin in all sides. Use red ink in border line as shown on the format
below.

PROBLEM SOLVING: Solve the problems with complete and neat solutions. Use blue or black ink only in
your answers. Erasures are considered wrong answers. See rubrics for distribution of points.
RUBRIC:
POINT SYSTEM
DESCRIPTION
(per requirement)
Complete solution with correct answer 5
Correct answer with missing solutions 3
Wrong solution or solutions that cannot be understood 1
No solution 0

ESSAY: Answer the following questions comprehensively and neatly. Use blue/black ink only. All answers
must be in engineering lettering. See rubrics for distribution of points.
RUBRIC:

DESCRIPTION POINT SYSTEM

CONTENT: Evidence and examples are vivid and specific 5
STRUCTURE: Effective, smooth, and logical transitions 5

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Study Schedule
ENGINEERING ECONOMICS (ECOENG1)
TTh 8:00 – 9:30AM HB207
FIRST GRADING
Week Inclusive Lesson Teaching Resources Assessment Submission of Task
No. dates Learning Tasks
activities Deadline Online

1 Aug 24- VMO, N/A N/A N/A

29, 2020 Course
Syllabus
Grading Module, Google
System Recorded/ meet, Google
2 Sept 2-5, 1&2 Online Forms, Google Sept 5,
2020 Lecture- Classroom 2020
3 Sept 7-12, 2 Discussion Sept 12, Google
2020 Activity, Quiz 2020 Classroo
4 Sept 14- 3 Sept 26, m
19, 2020 2020
5 Sept 21-
26, 2020
6 Sept 28- Online First Grading Examination
Oct 3,
2020
MIDTERMS
7 Oct 5- 4 Oct 10,
10,2020 2020
8 Oct 12-17, Oct 17,
2020 Module, Google 2020
9 Oct 19- 5&6 Recorded/ meet, Google Oct 31, Google
24,2020 Online Forms, Google 2020 Classroo
10 Oct 26- 6 Lecture- Classroom Activity, Quiz Nov. 7, m
31,2020 Discussion 2020
11 Nov 3-7, Nov 14,
2020 2020
12 Nov 9-14, Online Midterm Examination
2020
FINALS
13 Nov 16- 7 Nov 21,
21, 2020 2020
14 Nov 23- Module, Google Nov 28,
28, 2020 Recorded/ meet, Google 2020 Google
15 Dec 1-5, 7&8 Online Forms, Google Dec 5, Classroo
2020 Lecture- Classroom Activity, Quiz 2020 m
16 Dec 7-12, 9 & 10 Discussion Dec 12,
2020 2020
17 Dec 14- 10 Dec 19,
19, 2020 2020
18 Dec 21- Online Final Examination
24, 2020
Contact me through:
SMS (+63 9303924957) Messenger (Jasmin G. Madayag)
Email ([Link]@[Link])
City Address: 200 Cabinet-Hill, Teacher’s Camp, Baguio City

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Lesson 1 – Introduction to Engineering Economics

Learning Outcomes:
At the end of this lesson, the students can use the basic concept of engineering economics to
understand economic costs and apply it to real-life problems.

Engineering
 The profession in which a knowledge of mathematical and
natural science gained by study, experience, and practice is
applied with judgement to develop ways to utilize
economically the materials and forces of nature for the
benefit of mankind.

Economics
 A social science concerned with the production, distribution,
and consumption of goods and services.
Types of Economics
1. Microeconomics – focuses on the behavior of individual
consumers and producers
2. Macroeconomics – focuses on the overall scale of economy

Engineering Economy
 It is the analysis and evaluation of the factors that will affect the economic success of engineering
projects to the end that a recommendation can be made which will insure the best use of capital. (Sta.
Maria, Hipolito, 2000)

The Economic Environment

Necessities Luxuries

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Economic Products
A. Goods – economic product that is useful and satisfies an economic want.
B. Services – work performed to satisfy economic wants

Consumer goods and services are those goods or services that are directly used by people to satisfy
their needs. Producer goods and services are those goods or services that are used to produce consumer
goods and services.

Competition, Monopoly, and Oligopoly

Perfect competition occurs in a situation in which any given product is supplied by a large number of
vendors and there is no restriction in additional suppliers entering the market.
Perfect monopoly occurs when a unique product or service is available from a single supplier and the
vendor restricts the entry of other supplier in the market.
Oligopoly occurs when there are few suppliers and any action taken by anyone of them will definitely
after the course of action of the other.

The Law of Supply and Demand

Supply is the quantity of a certain commodity that is offered for sale at a certain price at a given place.
Demand is the quantity of a certain commodity that is bought at a certain price at a given place. (1)
Inelastic demand occurs when a decrease in selling price produces less than proportionate increase in sales.
(2) Elastic demand when a decrease in selling price results in a greater than proportionate increase in sales.

“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 the
demand being equal.”
***This law is used to know the actual market price and volume of goods. At
higher prices, the demand is less and the supply of economic good will
increase.

The Law of Diminishing Returns

“When the use of the one of the factors of the
production is limited, either in increasing cost or by
absolute quantity, a point will be reached beyond
which an increase cost or by absolute quantity, a
point will be reached beyond which an increase in the
variable factors will result in a less than proportionate
increase in output.”

Cost Terminologies
Fixed Cost
 Those costs which remain constant whether or not a given change in operations or policy is
adopted.

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Variable Cost
 Those costs that varies with the produced output or activity level.
 Variable cost can be solved by VC= (Variable cost per unit)(Total number of units)

Increment Cost
 Those costs are the result of a change or adjustment in operation or policy.
 It is the result of the difference of costs between alternatives.

Marginal Cost
 These costs are the additional cost of producing one or more unit of product.

Sunk Cost
 These costs are the investment that cannot be recovered for some reasons.
 Sunk cost can be solved by SC = Book Value – Resale Value
o (-) Sunk Cost indicates gain

Opportunity Cost
 It is incurred because of the use of limited resources such that the opportunity to use those
resources to monetary advantage in an alternative use is foregone.

Direct costs
 These are costs that can be reasonably measured and allocated to a specific output or work
activity. Examples are labor and material costs.

Indirect costs
 These are costs that are difficult to attribute or allocate to a specific output or work activity.
Examples are the costs of common tools, general supplies, and equipment maintenance.

Overhead cost
 It consists of plant operating costs that are not direct labor or direct material costs. Examples
are electricity, general repairs, property taxes and supervision.

Standard costs
 These are representative costs per unit of output that are established in advance of actual
production or service delivery.

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Lesson 2 – Selections on Present Economy

Learning Outcome:
At the end of the lesson, the students can use the basic concept of present economy studies in the
selection of alternatives.

Present Economy Studies

 These are studies that do not require consideration of time-money relationships. They generally involve
selection between alternative designs, materials, or
methods.

Rules for selecting alternatives in present economy

Rule 1: When revenues and other economic benefits are present
and vary among alternatives, choose alternative that maximizes
overall profitability based on the number of defect-free units.

Rule 2: When revenues and economic benefits are not present or

are constant among alternatives, consider only costs and select
alternative that minimizes total cost per defect-free output.

Sample Problem 1
The bottler of a popular soft drink can purchase glass bottles for Ᵽ 4.00 each or all-aluminum cans for Ᵽ
5.00 each. If the aluminum cans are used, she believes she can achieve a saving of Ᵽ 0.05 per can in shipping
and handling costs, owing to the reduced weight in addition, by setting up a reclamation drive, she believes
that she can recover about 50% of the cans by offering to pay Ᵽ 10.00 per pound for returned cans at four
return centers which she will establish in the area her company serves. The equivalent used cans are 20 per
pounds, and she can sell the used cans to the can manufacturer for Ᵽ 15.00 per pound. She estimates that the
overhead cost of operating the return centers will not exceed 20% of the cost of repurchasing the used cans. In
addition, she believes that she will obtain favorable response from ecology-minded customers. Which type of
beverage container would you recommend that she use?

Given:
 Using Glass bottles
Unit Cost of Glass bottle = Ᵽ 4.00

 Using Aluminum cans

Cost of All-aluminum cans = Ᵽ 5.00 each
Saving in shipping & handling costs = Ᵽ 0.05/can
Recover cans = 50% by offering Ᵽ 10.00/lb
Selling cost of used can = Ᵽ 15.00
Total used cans = 20 cans/lb

Required:
Cheaper type of beverage container

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Solution:
 Consider glass bottle type of container
Cost of glass bottle = Ᵽ 4.00 each

 Consider all-aluminum can type of container

Cost of aluminum can = Ᵽ 5.00 each
Cost of recovered cans = (Ᵽ 15.00 - Ᵽ 10.00)(50%)/ 20
= Ᵽ 0.125 per can
Cost of operating return centers,
= 20% (Ᵽ 10.00/20)(50%) per can
= Ᵽ 0.05 per can

Net cost of each can = Ᵽ 5.00 each - Ᵽ 0.125 - Ᵽ 0.05 + 0.05

= Ᵽ 4.875 each

 The glass bottle is cheaper by Ᵽ 0.875 per can, therefore the bottle type of container should be
recommended.

Sample Problem 2
A company finds that, on the average, two of its engineers spend 60 hrs each month in flying time,
using commercial airlines, in making service calls to customers’ plants, always traveling together. It finds that
the cost for airline tickets, airport buses, car rental; and so on, costs approximately Ᵽ 2,000 per person per
month. An air charter service offers to supply a small business jet and pilot on 24-hour notice at a cost of Ᵽ
1,200 per month plus Ᵽ 125 per hour of flying time and Ᵽ 25 per hour for waiting time on the ground at the
destination. It states that experience for similar situations has shown that total travel time will be reduced by
50% by using the charter service.
The company estimates that the cost of car rental at destinations using charter service probably would
amount to about Ᵽ 250 per month and the average “waiting time” is 40 hrs per month. It also estimates that
each engineer’s time is worth Ᵽ 40 per hour to the company, should the charter be used?

Given:
 Using the commercial airlines (Include Two Engineers)
Fare cost = Ᵽ 2,000 /person (including airline tickets, buses, car rental)
Flying time = 60 hrs/month
Flying time cost = Ᵽ 40 /hr
 Using the air charter
Flying time = 50 % (60 hrs/month)
Flying time cost = Ᵽ 125/hr
Cost of Jet & pilot hire = Ᵽ 1,200 /month
Waiting time Cost= Ᵽ 25 /hr
Average waiting time = 40 hrs/month
Car rental = Ᵽ 250 /month

Required:
Total costs for Air Charter

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Solution:
 Considering the commercial airline
Cost of Engineers’ time = Ᵽ 40 /hr (60 hrs/month) (2 persons)
= Ᵽ 4,800 per month
Total fare = Ᵽ 2,000 /month (2 persons)
= Ᵽ 4,000 /month
Total expenses = Ᵽ 4,800 + Ᵽ 4,000 = Ᵽ 8,800 /month

 Considering the air charter

Total Flying time = 50% (60 hrs/month) = 30 hrs/month

Flying time cost = Ᵽ 125 /hr (30 hrs/month)

= Ᵽ 3750 /month
Cost of Engineer’s time = Ᵽ 40 /hr (30 hrs/month) (2 persons)
= Ᵽ 2,400 per month
Waiting time cost = Ᵽ 25 hr (40 hrs/month)
= Ᵽ 1000 /month
Cost of hiring = Ᵽ 1200 /month
Cost of car rental = = Ᵽ 250 /month

Total expense for air charter,

= Ᵽ 3,750 + Ᵽ 2,400 + Ᵽ 1,000 + Ᵽ 1,200 + Ᵽ 250
= Ᵽ 8,600 /month

 The total expense for air charter is cheaper by Ᵽ 200 /month than the commercial airlines;
therefore air charter should be used.

Sample Problem 3
The assembly of a certain component for television sets has been done by two skilled workers, each of
whom is paid Ᵽ 40.00 per hour and can produce 10 units per hour (as a group). For the 10 units, one will be
defective and will have to be discarded at a material loss of Ᵽ 25.00. It has been proposed that this operation
could be done by three persons of lesser skill, who would be paid only Ᵽ 35.00 per hour, and who, as a group,
could complete 13 units per hour. It is estimated that the number of defects per hour would not be changed if
this alternative procedure is used. Which procedure would you recommend?

Given:
 Two-skilled worker
Labor = Ᵽ 40.00 /hr
Produce units = 10 units /hr (1 out of 10 is defective)
Cost of material loss = Ᵽ 25.00
 Three less skilled worker
Labor = Ᵽ 35.00 /hr
Produce units = 13 units /hr (1 out of 13 is defective)
Cost of material loss = Ᵽ 25.00

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Required:
Best procedure to be used
Solution:
 Consider the two-skilled worker
Total Labor Cost = Ᵽ 40.00 /hr x 2 workers
= Ᵽ 80.00 /hr

Cost of material loss for 1 defective = Ᵽ 25.00 /hr

Total cost = Ᵽ 80.00 + Ᵽ 25.00 = Ᵽ 105.00 /hr
Cost per acceptable piece = Ᵽ 105.00 /hr / 9 units /hr
= Ᵽ 11.67 per unit
 Consider the three less skilled worker
Total Labor Cost = Ᵽ 35.00 /hr x 3 workers
= Ᵽ 105.00 /hr

Cost of material loss for 1 defective = Ᵽ 25.00 /hr

Total cost = Ᵽ 105.00 + Ᵽ 25.00 = Ᵽ 130.00 /hr

Cost per acceptable piece = Ᵽ 130.00 /hr / 12 units /hr

= Ᵽ 10.83 per unit

 The second procedure gives the cheaper price per unit than the first procedure; therefore the
second group is to be recommended.

Check for facts – First Grading Activity 1

I. Essay: See instructions and rubric at the start of this schedule.

1. Why is engineering economy important in your chosen field?

2. Differentiate necessity and luxury.
3. Explain law of diminishing returns.

II. Problem Solving: See instructions and rubric at the start of this module.

Problem: An executive receives an annual salary of ₱ 600,000 and his secretary a salary of ₱180,000. A
certain task can be performed by the executives working alone in 4 hours. If he delegates the task to his
secretary it will require him 30 minutes to explain the work and another 45 minutes to check the finished work.
Due to the unfamiliarity of the secretary to the task, it takes her an additional time of 6 hours after being
instructed. Considering salary cost only, determine the cost of performing the task by each method, if the
secretary work 2,400 hours a year and the executive 3,000 hours a year.

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Lesson 3 – Money-time Relationship

Topics:
Simple Interest
Compound Interest
Continuous Compounding
Discount
Inflation
Annuity
Perpetuity
Capitalized Cost
Gradient Series

Learning Outcomes:
At the end of the lesson, the students should be able to:
1. Understand the concept of money-time relationship.
2. Apply the concept by solving engineering problems.
3. Know the application of this relationship to real life situation.

Interest
 It is the amount of money paid for the use of borrowed capital or the income produced by money which
has been loaned.
Simple Interest
 It is one way to calculate interest for a short-term loan or investment.
 It is calculated using the principal only in days.
 (1) Ordinary Simple Interest, (2) Exact Simple interest

Interest, I = Pni
Future Amount, F = P + I = P + Pni = P (1+ni)

Where:
P – Principal amount
n – Number of interest periods
i – Rate of interest per interest period
Types of Simple Interest
1. Ordinary Simple Interest
 The interest is based on 30 days in each month.
 1 interest period = 360 days/year

Sample Problem 1
A man borrowed ₱ 100,000 and promised to pay after 5 months at a simple interest of 8%. How much
is the ordinary simple interest?

Given:

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 P = ₱ 100,000 i = 8% n = 5 months
Required:

Interest, I
Solution 1: (Converting n in days)
Calculate the total number of days, n = 5 mo x 30 days/mo = 150 days
Then substitute in the formula:
I = Pni
I = ₱ 100,000 x (150 days/360 days/yr) x 0.08
I= ₱ 3,333.33

Solution 2: (Using n in months)

I = Pni
I = ₱ 100,000 x (5 mo/12 mo/yr) x 0.08
I= ₱ 3,333.33

Sample Problem 2
Determine the ordinary simple interest on P700 for 8 months and 25 days if the rate of interest is 15%.
Given:
P = ₱ 700 i = 15% n = 8 months and 25 days
Required:
Interest, I
Solution:
Number of days, n= (8) (30) + 15= 255 days
255
I = Pni = P700 x x 0.15
360
Interest, I = P74.38

Sample Problem 3
A loan of ₱ 2000 is made for a period of 13 months, from January 1 to January 31 the following year, at
simple interest of 20%. What is the future amount is due at the end of the loan period?
Given:
P = ₱ 2000 i = 20% n = 13 months
Required:
Future amount, F
Solution:
F = P(1 + ni)
255
F = ₱ 2000 [1 + 360
)(0.20)]
F = ₱ 2,433.33

2. Exact Simple Interest

 The interest is based on the exact number of days in a year.
 1 interest period = 365 days or 366 days (Leap year)
 Note: Use ESI when the given time is complete (Month, day and year)

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Sample Problem 1
A man borrowed ₱ 100,000 on September 18, 1898 and promised to pay on February 28, 1899 at a
simple interest of 8%. How much will be the total interest?

Given:
P = ₱ 100,000
i = 8%
n = Sep. 18, 1898 – Feb. 28, 1899
Required:
Interest, I
Solution:
September 18-30 = 12
October = 31
November = 30
December = 31
January = 31
February = 18
Total = 153 days

Interest, I = ₱ 100,000 x (153 days/365 days/yr) x 0.08

Interest, I = ₱ 3,353.42

Sample Problem 2
Determine the exact simple interest on P500 for the period from January 10 to October 28, 1996 at
16% interest.
Given:
P = ₱ 100,000
i = 8%
n = Sep. 18, 1898 – Feb. 28, 1899
Required:
Interest, I
Solution:
Jan 10-31 = 21 (excluding Jan 10)
February = 29
March =31
April =30
May =31
June =30
July =31
August =31
September =30
October = 28 (including Oct.28)
Total = 292 days

292
Exact simple interest =₱ 500
366 (0.16)

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 Exact simple interest = ₱ 63.83

Cash Flow Diagram

Cash flow diagram is a graphical representation of cash flows drawn in a time scale. It has three
elements:
1. A horizontal line represents time with progression of time moving from left to right. The period labels
can be applied to intervals of time rather than to point on the time scale. A time interval is divided into
an appropriate number of equal periods.

2. Arrows represent cash flow and are place at the specified period. If distinctions are needed to be made,
downward arrows represent cash outflows (expenditures, disbursements) and upward arrows
represents cash inflows (income).

3. Depends on the person’s viewpoint. Unless otherwise indicated, all such cash flows are considered
to occur at the end of their respective periods.

Example: A loan of 100 at simple interest of 10% will become P150 after 5 years.

Cash flow diagram on the viewpoint of the lender

P100

0 1 2 3 4 5

P150
Cash flow diagram on the viewpoint of the borrower

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The Five Types of Cash Flows
Whenever patterns are identified in cash flow transactions, these patterns can be used to develop
concise expressions for computing either the present or future worth of the series. Cash flows can be classified
into five categories:

1. Single Cash Flows: The simplest case involves the equivalence of a single cash present amount
and its future worth. Thus, the single-cash flow formula deal with only two amounts: the single
present amount P, and its future worth F.

2. Equal Uniform Series: Probably the most familiar category includes transactions arranged as a
series of equal cash flows at regular intervals, known as an equal-payment series (or uniform series)
3. Linear Gradient Series consists of cash flows that increase or decrease by uniform amount each
periods.
4. Geometric Gradient Series consist of cash flows that increase or decrease by a fixed percentage.
5. Irregular Series consists of cash flows that change with no pattern.

Compound Interest
 It is an interest that is earn from the principal and the accumulated interest.

Present Amount, P = F (1+i)-n

Future Amount, F = P (1+i)n

Where:
n – Number of interest periods
i – Rate of interest per interest period

0 1 2 3 n

F
Cash flow diagram for compound interest (Borrower’s Viewpoint)

Derivation of Formula

Interest Principal at Interest Earned Amount at End

Period Beginning of During Period of Period
Period
1 P Pi P+Pi = P(1+ni)

2 P(1+i) P(1+i) i P(1+i) + P(1+i)i

= P(1+I) ²

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 3 P(1+i)² i P(1+i) ² i P(1+i) ² + P(1+i) ²i
=P(1)

... ... ... ...

N P(1+i) n-1 P(1+i) n-1i P(1+i) ⁿ

F = P (1+i)n
The quantity (1+i)nis commonly called the “single payment compound amount factor” and is designed
by the functional symbol F/P, i%, n. Thus,
F = P (F/P, i%, n)
The symbol F/P, i% n is read as “F given P at per cent in n interest period.” From Equation (2-3),
P = F(1+i)-n
The quantity (1-i)-nis called the “single payment present worth factor” and is designated by the
functional symbol P/F, i% ,n. Thus,
P = F (P/F i% n)
The symbol P/F, i%, n is read as “P given F at i percent in n interest periods.”
Sample Problem
A P2000 loan was originally made 8% simple interest for 4 years. At the end of this period th loan was
extended for 3 years, without the interest being paid, but the new interest rate was made 10% compounded
semi annually. How much should the borrower pay at the end of the 7 years?
Solution:

F4 = P(1 + ni ) = P2000 1 + (4) (0.08) = ₱ 2,640

F7 = F4 (1 + i )n = P2,640 (1 +0.05)6 = ₱ 3,537.86

Rate of Interest
 is defined as the amount earned by one unit of principal during a unit of time

(a) Nominal rate of interest

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 Nominal rate of interest specifies the rate of interest and the number of compounding period in one
year. It has because customary to wrote interest rates on an annual basics followed by the compounded period
if different from one year in length.
�
i=
�
where:
i = rate of interest per interest period
r = nominal interest rate
m = number of compounding periods per year

If the nominal rate o interest is 10%compounded quarterly, then i= 10%/4= 2.5%, the rate of interest per
interest period.

Compounding Period Occurrence per year Value of m

Annually once a year 1
Semi-annually twice a year 6
Quarterly every 3 months 4
Monthly every month 12
Continuously indefinite ∞

Sample Problem
The sum of P10, 000 was deposited to a fund earning interest 10% per annum compounded quarterly,
what was the principal in the fund at the end of a year?
Given:
P = 10,000
r= 10% per year compounded quarterly
n= 3 years (4) = 12 quarters
Required:
The amount in the fund at the end of 3 years
Solution:
Solving for the rate of interest per period,
� 10
i= =
� 12
i = 2.5% per quarter

(b) Effective rate of interest

Effective rate of interest is the actual or exact rate of interest on the principal during one year.
ERI = (1+i)ᵐ -1
where:
i = rate of interest per interest period
m = number of compounding periods per year

Sample Problem 1
Consider, one unit of principal for one unit a time invested in a nominal interest of 12% compounded

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monthly. Determine the effective rate of interest.
Given:
P = 1.00
n = 12 months
i = 12%/12 = 1%/ month
Required:
Effective rate of interest (ERI)
Solution:
The accumulated amount of P for one year will be
F = P(1+i)ⁿ = 1(1 + 0.01)ⁿ
F = P1.1268
The implication is that, for one unit of principal. The interest earned will be
I = 0.1268
and in terms of effective or actual annual interest (ERI) the interest can be rewritten as a percentage of
the principal amount:
ERI = I/ P = 0.1268 / 1
ERI = 12.68% (paying 1% interest per month for 12 months is equivalent to paying 12.68%
interest just one time each year)
Sample Problem 2
Find the nominal rate which if converted quarterly could be used instead of 12% compounded monthly.
What is the corresponding effective rate?
Given:
i = 12% CM
Required:
Nominal Rate, r
Solution:
Let r= the unknown nominal rate

For two or more nominal rates to be equivalent, their corresponding effective rates must be equal:
Nominal rate Effective rate
�
r% compounded quarterly 1 + 4 -1
4
0.12
12% compounded monthly 1+ -1
12
12

� 4
1+ − 1 = 1(0.01)12-1
4
�
1 + 4= (1.01)3 =1.0303

r = 0.1212 or 12.12% compounded quarterly

Sample Problem 3
A loan of P10,000 for 3 years at 10% simple interest per year. Determine the interest earned and the

A Self-regulated Learning Module 20

accumulated amount.

Given:
P = P10,000
n = 3 years
i = 10% per year
Required:
a. Total Interest, I
b. Accumulated amount, F

Solution:
a. The total interest earned:
I = Pni
I = P10,000 (3 years) (0.1/year)
I = P3,000.00

b. The accumulated amount at the end of the interest period:

F= P + I
F = P10,000 + 3,000
F = P13,000.00

Amortization Schedule
- A table showing the mode of payment.

Period Principal Interest Payment

1 10, 000 1, 000 0
2 10, 000 1, 000 0
3 10, 000 1, 000 13, 000
Total 3, 000

Equation of Value
If cash flows occur on different periods, comparison of such should be made on a same focal date.
Equation of values is obtained by setting the sum of one set of obligation on a certain comparison or focal date
equal to the sum of another set of obligation on the same date.
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.
Application of Compound Interest
Deposits ------- withdrawals
Loans ---------- repayments
Investment ---- income
Cash inflow --- cash outflow

Sample Problem
A man bought a lot worth ₱1,000,000 if paid in cash. On the installment basis, he paid a down payment
of ₱20,000; ₱300, at the end of one year, ₱400, at the end of three years and a final payment at the end of five

A Self-regulated Learning Module 21

years. What was the final payment if interest was 20%
Given:
P = ₱1,000,000
Q0 = ₱200,000
Q1 = ₱300,000
Q3 = ₱400,000
n = 5 years
i = 20%
Required:
Final Payment, Q5
Solution:
₱800,000

0 1 2 3 4 5

₱300,000
300,000(P/F,20%,1)
₱400,000
₱400,000(P/F,20%,3) Q5

Q(P/F,20%,5)

Using “0” as the focal date, the equation of value is

P800, 000 = P300,000 (P/F,20%,1) + P400,000 (P/F,20%,3) + Q (P/F, 20%,5)
P800, 000 = P300,000 (1.20)-1 + P400,000 (1.20)-3 + Q (1.20)-5
P800, 000 = P300,000 (0.8333)+ P4000, 000 (0,5787) + Q (0.4019)
Q5= P792,560.00

Continuous Compounding and Discrete Payments

In discrete compounding the interest is compound at the end of each finite- length period, such as a
month, a quarter or a year. In continuous compounding, it is assumed that cash payments occur once per
year, but the compounding is continuous throughout the year.

A Self-regulated Learning Module 22

 Cash flow diagram Continuous Compounding (Lender’s Viewpoint)
r mn
F = P 1+m

Where:
r = nominal rate of interest per year
�
�
= rate of interest per period
m = number of interest periods per year
n = number of interest periods in n years

m
Let r
= k, then m = rk, as m increases so must k
� 1 rkn 1 k rn
1+� mn
= 1+ = 1+
� �
� k
The limit of 1 + � as k approaches infinite is e
1 k rn rn
1+ =e
�

Thus, F= Pert (Continuous Compounding)

Sample Problem
Compare the accumulated amounts after 5 years of P1,000 invested at the rate of 10% per year
compounded (a) annually, (b) semiannually, (c) quarterly, (d) monthly, I daily, and (f) continuously.
Given:
P = ₱ 1,000
n = 5 years
Required:
Future amount, F
Solution:
Using the formula, F = P(1+i)nm
(a) F = ₱ 1,000 (1+0.10)5(1) = ₱ 1,610.51
0.10 2(5)
(b) F = ₱ 1,000 1 + = ₱ 1,628.89
2
0.10
(c) F = ₱ 1,000 1 + 4 4(5)
= ₱ 1,638.62

0.10
(d) F = ₱ 1,000 1 + 12(5)
= ₱ 1,645.31
12
0.10
(e) F = ₱ 1,000 1 + 365(5)
= ₱ 1,628.89
365
(f) F = Pern = ₱ 1,000e(0.10x5) = ₱ 1,648.72

A Self-regulated Learning Module 23

Check for Facts – First Grading Activity 2

1. If you borrow money from your friend with simple interest of 12%, find the present worth of ₱ 20,000,
which is due at the end of nine months.
2. By the condition of a will, the sum of ₱ 25,000 is left to be held in trust by her guardian until it amounts
to ₱ 45,000. When will the girl receive the money if the fund is invested at 8% compounded quarterly?

3. A debt of ₱ 80,000 is to be paid after 6 years at an interest rate of 4% compounded monthly. Find the
amount to be paid after 6 years.

4. Convert 12% compounded quarterly per year into compounded semi-annually per year.

5. A man borrowed ₱ 75,000 on September 18, 1898 and promised to pay on May 17, 1904 at a simple
interest of 12% per annum. How much will be the total interest?

Assessment – First Grading Quiz 1

1. A man wishes his son to receive ₱ 200,000 ten years from now. What amount should he invest if it will
earn interest of 10% compounded annually during the first 5 years and 12% compounded quarterly
during the next 5 years?

2. At a certain interest rate compounded semiannually ₱ 5,000 will amount to ₱20,000 after 10
years. What is the amount at the end of 15 years?

3. Jones Corporation borrowed ₱ 9,000 from Brown Corporation on Jan. 1, 1978 and ₱ 12,000 on Jan. 1,
1980. Jones Corporation made a partial payment of ₱ 7,000 on Jan. 1, 1981. It was agreed that the
balance of the loan would be amortized by two payments one of Jan. 1, 1982 and the other on Jan. 1,
1983, the second being 50% larger than the first. If the interest rate is 12%. What is the amount of each
payment?

4. How long will it take the money to double itself if invested at 4% compounded annually?

5. If ₱ 5,000 shall accumulate for 10 years at 8% compounded quarterly. Find the compounded
interest at the end of 10 years.

6. In how many years is required for ₱ 2,000 to increase by ₱ 3,000 if interest at 12%
compounded semi-annually?

7. A loan was made 3 years and 4 months ago at 6% simple interest. The principal amount of the
loan has just been repaid along with ₱ 800 of interest. Compute the principal amount of the
original loan.

8. You loan from a firm an amount of ₱100,000 with a rate of simple interest of 20%, but the
interest was deducted from the loan at the time the money was borrowed. If at the end of one
year, you have to pay the full amount of ₱100,000, what is the actual rate of interest?

A Self-regulated Learning Module 24

Discount
Discount is defined as interest deducted in advance. 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 interest paid in advance.
Discount = Future Worth – Present Worth
The rate of discount is the discount on one unit of principal for one unit of time.
��������
d=
���������
� �
d= ;i=
�+� �−�
where:
d = rate of discount for the given period
i = rate of interest for the same period

Sample Problem
A man borrowed ₱5,000 from a bank and agreed to pay the loan at the end of 9 months. The bank
discounted the loan and gave him ₱4,000 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?
Given:
P = ₱5,000
F = ₱4,000
n = 9 mo
Required:
a) d, b) i, c) i for 1 year
Solution:
�������� �1,000
(a) d = = = 0.20 or 20%
��������� � 5,000
� 0.20
(b) i = = = 0.25 or 25%
1−� 1−0.20
Another solution,
�������� �1,000
i= = = 0.25 or 25%
������� ����ℎ (� 4,000)
� �1,000
(c) i =
��
= 9 = 0.3333 or 33.33%
(� 4,000)
12

Inflation
Inflation is the increase in the prices for goods and services from one year to another, thus decreasing
the purchasing power of money.
FC = PC (1+ f)n

A Self-regulated Learning Module 25

 where:
PC = present cost of a commodity
FC = future cost of the same commodity
f = annual inflation
n = number of years

In an inflationary economy, the buying power of money decrease as cost increase. Thus,
�
F=
1+� �
If interest is being compounded at the same time that inflation is occurring. The future worth will be

�(1+�)� 1+� n
F= =P
(1+�)� 1+�

where:
P = present worth of a commodity
F = future worth of the same commodity
f = annual inflation
n = number of years

Sample Problem 1
An economy is experiencing inflation at the annual rate of 8%. If this continuous, what will ₱1000 be
worth two years from now, in terms of today’s peso?
Given:
f = 8%
P = ₱ 1000
n = 2 years
Required:
Future Worth, F
Solution:
� �1000
F= � =
(1+�) (1+0.08)�
F = ₱857.34

Sample Problem 2
A man invested ₱10,000 at an interest rate of 10% compounded annually. What will be the final amount
of his investment, in terms of today’s pesos, after five years, if inflation remains the same at the rate of 8% per
year?
Given:
P = ₱ 10,000
i = 10%
r = 8%
n = 5 years
Required:
Future Amount, F

A Self-regulated Learning Module 26

Solution:
5
(1+�) n (1+0.10)
F = P( ) = P10,000
(1+�) (1+0.08)
F = P10,960.86

ANNUITY
An annuity is a series of equal payments made at equal intervals of time. Financial activities like
installment payments, monthly rentals, life-insurance premium, monthly retirement benefits, are familiar
examples of annuity.

Symbols used in Annuity

P = Present amount
F = Future amount
A = A series of periodic, equal amounts of money
n = Number of interest periods
i = Interest rate per interest period

1. Ordinary Annuity
An ordinary annuity is a series of payment which starts at the end of each year until a definite
period of time.

Characteristics of ordinary annuity:

a.) P (present equivalent value)
- Occurs one interest period before the first A (uniform amount)
b.) F (future equivalent value)
- Occurs at the same time as the last A and n intervals after P
c.) A (annual equivalent vale)
- Occurs at the end of each period

A Self-regulated Learning Module 27

Finding P when A is given
P

0 1 2 3 n-1 n

A A A A A
A(P/F,i%,1)
A(P/F,i%,2)

A(P/F,i%,3)

A(P/F,i%,n-1)

A(P/F,i%,n)

Cash flow diagram to find P given A

Using equation of value,“0” as focal point:

P = A (P/F, i%, 1) + A (P/F, i%, 2) + (P/F, i%, 3) +……. + A (P/F, i%, n-1) + A (P/F, 1%, n)
P = A (1+i)-1 + A (1+i)-2 + …… + A (1+i)-(n-1) + A (1+i)-n
Multiplying this equation by (1+i) result in
P + Pi = A + A (1+i)-1 + A (1+i)-2 + …… + A (1+i)-n+2 + A (1+i)-n+1
Subtracting the first equation from the second gives
P + Pi = A + A (1+i)-1 + A (1+i)-2 +…………… + A (1+i)-n+1
-P = - A (1+i)-1 - A (1+i)-2 +…………… + A (1+i)-n+1 – A (1+i)-n

Pi =A – A (1+i)-n

Solving For P gives

−1 �
1− 1+� 1+� −1
P=A =A
� �(1+�)�

The quantity in brackets is called the “uniform series present worth factor” and is designated by the
functional symbol P = A (P/A, i%, n), read as “P given A at I percent in the interest periods. “

Finding A when P is Given

Taking Equation and solving for A, we have
�
A=P
1− 1+� −�

A Self-regulated Learning Module 28

Finding F when A is Given
F

0 1 2 3 n-1 n

A A A A A

A(F/P,i%,1)

A(F/P,i%,n-3)

A(F/P,i%,n-2)

A(F/P,i%,n-1)

Cash flow diagram to find F given A

Using equation of value, “n” as focal point:

F = A + A (F/A, i%, 1) + ……. + A (F/P, i%, n-3) + A (F/P, 1%, n-2) + A(F/P, i%, n-1)
F = A + A (1+i) + ……… + A (1+i)-(n-3) + A (1+i)-n-2 + A (1+i)-n-1
Multiplying this equation by (1+i) results in
F + Fi = A + A (1+i) + A (1+i)2 + …… + A (1+i)n-2 + A (1+i)n-1 + A (1+i)n
Subtracting the First equation from the second gives
F + Fi = A (1+i) + ………. + A (1+i) n-2 + A (1+i)n-1 + A (1+i)n
- F = -A- A (1+i) + …… + A (1+i) n-2 + A (1+i)n-1

Fi = -A + A (1+i) n

Solving for F gives

�
1+� −1
F=A �

The quantity in brackets is called “Uniform series compound amount factor” and is designated by the
functional symbol F/A, i%, n, read as “F given at I percent in n interest period.”
Finding A When F is Given
Taking Equation and solving for A, we have

�
A=F �
1+� −1

A Self-regulated Learning Module 29

Sample Problem 1
What are the present worth and the accumulated amount of a 10-year annuity paying P10,000 at the
end of each year, with interest at 15% compounded annually?
Given:
P = ₱10,000.00
i = 15%
n = 10 years
Required:
a. Present Worth, P
b. Future Worth, F
Solution:

a. For present worth, P

Solution 1 (Formula-based)
P = A(P/A, i%, n) = P10,000 (P/A, 15%, 10)
1− 1.15 −10
= ₱10,000 [ .15
]
P = ₱50,188.00

Solution 2 (Equation of value, “0” as focal point)

P(1 + i)0 = ₱10,000 (1 + 0.15)-1 + ₱10,000 (1 + 0.15)-2 + ₱10,000 (1 + 0.15)-3 + ₱10,000 (1 + 0.15)-4 +
₱10,000 (1 + 0.15)-5 + ₱10,000 (1 + 0.15)-6 + ₱10,000 (1 + 0.15)-7 + ₱10,000 (1 + 0.15)-8 + ₱10,000 (1
+ 0.15)-9 + ₱10,000 (1 + 0.15)-10
P = ₱50,188.00
b. For future worth, F
Solution 1 (Formula-based)
F = A(F/A, i%, n) = P10,000 (F/A, 15%, 10)
(1.15)10 −1
= ₱10,000 [ .15
] = P203,037

F = ₱203,037.00

A Self-regulated Learning Module 30

Solution 2 (Equation of value, “0” as focal point)
F(1 + i)-10 = ₱10,000 (1 + 0.15)-1 + ₱10,000 (1 + 0.15)-2 + ₱10,000 (1 + 0.15)-3 + ₱10,000 (1 + 0.15)-4 +
₱10,000 (1 + 0.15)-5 + ₱10,000 (1 + 0.15)-6 + ₱10,000 (1 + 0.15)-7 + ₱10,000 (1 + 0.15)-8 + ₱10,000 (1
+ 0.15)-9 + ₱10,000 (1 + 0.15)-10
F = ₱203,037.00

Sample Problem 2
What is the present worth of P500 deposited at the end of every three months for 6years if the interest
rate is 12% compounded semiannually?
Given:
P = ₱ 500
n = 6 years
m=2
i = 12% CS
Required:
Present Worth, P
Solution:
Solving for the interest rate per quarter,
2
(1+i) 4 – 1 = 1 + 0.12
2 –1

1 + i = (1.06) .5
i = 0.0296 or 2.96% per quarter
P = A (P/A, 2.96%, 24)

1−(1+0.0296)−24
= ₱500
0.0296
= ₱500 (17.0087)
P = ₱ 8,504.00

Sample Problem 3
Today, you invest ₱100,000 into a fund that pays 25% interest compounded annually. Three years later,
you borrow ₱50,000 from a bank at 20% annual interest and invest in the fund. Two years later, you withdraw
enough money from the fund to repay the bank loan and all interest due on it. Three years from this withdrawal
you start taking ₱20,000 per year out of the fund. How much was withdrawn?

A Self-regulated Learning Module 31

Solution:

Withdrawal
₱50,000(1.20)2 (F/P, 25%, 7)
₱50,000(1.20)2
₱20,000(F/25%, 5)
₱20,000 each

0 1 2 3 4 5 6 7 8 9 10 11 12

₱50,000
₱50,000 (F/P, 25%, 9)

₱100,000
₱100,000 (F/P, 25%, 12)

Investment

Let Q = the amount withdrawn after 12 years

Using 12 years from today as the focal date, the equation of value is
Q + P20,000 (F/A, 25%, 5) + P50,000 (1.20)2(F/P, 25%, 7) = P100,000 (F/P, 25%, 12) + P50,000 (F/P, 25%, 9)
(1+.25)5−1
Q + P20,000 + P50,000 (1.20)2 (1.25)7 = P100,000 (1.25)12 + P50,000 (1.25)9
.25
Q + P20,000 (8.2070) + P50,000 (1.20)2(4.7684) = P100,000(14.5519)+P50,000 (7.4506)
Q = P1,320,255

Sample Problem 4
A debt of P5,000 with interest at 12% compounded semi-annually is to be amortized by equal semi-annual
payments over the next 3 years, the first due in 6 months. Find the semi-annual payment and construct an
amortization schedule.
Solution:
� �5,000
A =� = 1−(1.06)−6
= ₱ 1,016.81
, 6%,6
� .06

Amortization Schedule

Period Outstanding principal Interest due at Payment Principal repaid at

at beginning of period end of period the end of period

A Self-regulated Learning Module 32

 1 P5,000 P300.00 P1,016.81 P716.81
2 4,283.19 256.9914 P1,016.81 759.8186
3 3,523.3714 211.4022 P1,016.81 805.4077
4 2,717.9637 163.0778 P1,016.81 853.7322
5 1,864.2315 111.8589 P1,016.81 904.9561
6 959.2754 57.5565 P1,016.81 959.2535
TOTALS P1,100.89 P6,100.86 P5,000
2. Deferred Annuity
A deferred annuity is a type of annuity where the first payment is made several periods after
the beginning of the annuity.

m periods n periods

0 1 2 n-1 n
0 1 2 m

A A A A
A (P/A,i%,n) (P/F,i%,n) A (P/A,i%,n)

Cash flow diagram given A to find P

P = A (P/A, i%, n) (P/F, i%, m)
1−(1+�)−�
P=A (1 + i)−m
�
Where :
m = deferred period
n = number of annuities
*Note that the counting of m is up to the period before the first A.

Sample Problem 1
On the day his grandson was born, a man deposited to a trust company a sufficient amount of money
so that the boy could receive five annual payments of P80,000 each for his college tuition fees, starting with his
18th birthday. Interest at the rate 12% per annum was to be paid on all amounts on deposit. There was also a
provision that the grandson could select to withdraw no annual payments and received a single lump amount
on his 25th birthday. The grandson chose this option.
(a)How much did the boy received as the single payments?
(b)How much did the grandfather deposit?
Solution:
Let P=the amount deposited
X=the amount withdrawn
X
P80,000 P80,000 P80,000 P80,000 P80,000

A Self-regulated Learning Module 33

 0 18 19 20 21 22 23 24 25
P

The P80,000 supposed withdrawals are represented by broken lines, since they did not actually occur.
Three separated cash flows diagrams can be drawn.
(a)
X
P80,000 (F/A, 12%, 5) ₱80,000(F/A,12%,5)(F/P,12%,3)

P80,000P80,000P80,000P80,000P80,000

17 18 19 20 21 22 23 24 25

X and the P80,000 supposed withdrawals are equivalent.

Using 25 years of age as the focal date, the equation of value is

X = ₱80,000 (F/ A, 12%, 5)(F/P, 12%, 3)
(1+.12)5 −1
= ₱80,000 (1+.12)3
.12
X = ₱714,023.4509

(b)

₱ 80,000(P/A,12%,5)(P/F,12%,17) ₱80,000(P/A,12%,5)
P80,000

0
17 18 19 20 21 22

P and ₱80, 000 supposed withdrawals are equivalent.

Using today as the focal date, the equation of value is

P = P80,000 (P/ A, 12%, 5) (P/F, 12%, 17)
1−(1+.12)−5
= P80,000 (1+.12)-17
.12
P = P42,001.22
Sample Problem 2

A Self-regulated Learning Module 34

 If P10, 000 is deposited each years for 9 years, how much annuity can a person get annually from the
bank every year for 8 years starting 1 year after the 9th deposit is made. Cost of money is 14%.
Solution:
A(P/A, 14%, 8)(P/F,14%, 9) A(P/A, 14%, 8)

A A A A

₱10,000

₱10,000(P/A, 14%, 9)

Using today as the focal date, the equation of value is

A (P/ A, 14%, 8) (P/F, 14%, 9) = P10,000 (P/ A, 14%, 9)

1−(1+.14)−8 1−(1+.14)−9
A (1+.14)-9 = P10,000
.14 .14
A (4.63886) (0.30751) = P10,000 (4.94637)
A = P34,675

3. Annuity Due
An annuity due is series of uniform cash flows that occur at the beginning of each period
Finding P When A is Given
P

0 1 2 3 n-1 n

Cash flow diagram given A to find P

P = A + A (P/A, i%, n-1)
P = A (1 + P/A, i%, n-1)

1−(1+�)−(�−1)
P=A +A
�
1−(1+�)−(�−1)
P=A � + 1

Finding F When A is Given

F

A Self-regulated Learning Module 35

 0 1 2 3 n-1 n

A A A A A

Cash flow diagram given A to find F

F = A (F/A, i%, n+1) – A
F = A [(F/A, i%, n+1) -1

1−(1+�)−(�−1)
F=A -A
�
(1+�)(�+1)−1
F=A � − 1

Sample Problem
A certain property is being sold and the owner received two bids. The first bidder offered to pay
P400,000 each year for 5 years, each payment is to be made at the beginning of each year. The second bidder
offered to pay P240,000 first year, P360,000 the second year and P540,000 each year for the next years, all
payments will be made at the beginning of each year. If money is worth 20% compounded annually, which did
should the owner of the property accept?
Solution:
First bid
P1

0 1 2 3 4 5

400,000 400,000 400,000

400,000 400,000

Let P1= present worth of the first bid

P1= A (1 + P/ A,20%, 4)
= P400,000(1 + P/ A, 20%, 4)

1−(1+.20)−4
= P400,000 1 +
.20
= P 400,000 (3.5887)
P1 = P1,435,480
Second bid
P2

A Self-regulated Learning Module 36

 0 1 2 3 4 5

240,000
360,000

540,000 540,000 540,000

Let P2 = present worth for the second bid

P2 =P240,000 + P360,000( P/F, 20%,1)+ P540,000 (P/A,20%, 3)(P/F,20%,1)

1−(1+.20)−3
= P240,000 + P360,000 (1+.20)-1 + P540,000 (1+.20)-1
.20
=P240,000 + 360,000(0.8333) + P540,000 (2.1065)(0.8333)
P2 =P1,487,875
The owner of the property should accept the second bid.

Check for Facts – First Grading Activity 3

Problem Solving: See instructions and rubric at the start of this module.

1. Mr. J dela Cruz borrowed money from a bank. He received from the bank ₱ 1,340.00 and
promised to pay ₱ 1,500.00 at the and of 9 months. Determine the following:
a. Simple interest rate.
b. Banker’s discount.

2. Mr. Reyes borrows ₱ 600,000 at 12% compounded annually, agreeing to repay the loan in 15
equal annual payments. How much of the original principal is still unpaid after he has made the
8th payment?

3. What is the future worth of ₱ 600 deposited at the end of every month for 4 years if the interest
is 12% compounded quarterly?

4. Find the difference between the sums of an annuity due and an ordinary annuity for the
following data:

Periodic payment ₱ 14,000

Payment Interval 3 months
Term 16 years
Interest rate 10% compounded quarterly

A Self-regulated Learning Module 37

 5. A man loans ₱ 192,000 and promised to pay for 8 years at an interest rate of 5% compounded annually,
the first payment being due at the end of 10 years. Find the annual payment.

Assessment – First Grading Quiz 2

Problem Solving: See instructions and rubric at the start of this module.
1. A bill for motorboat specifies the cost as ₱ 1,200 due at the end of 100 days but offers a 4% discount
for cash in 30 days. What is the highest rate, simple interest at which the buyer can afford to borrow
money in order to take advantage of the discount?

2. Calculate the present worth of the money if the ₱ 300.00 is invested at the end of each year for 8 years
and the first payment was made 3 years from now. Use an annual interest rate of 8%.

3. Determine the accumulated amount of an annuity consisting of 6 payments of ₱12,000.00 each, the
payments are made at the beginning of each year. Money is worth 15% compounded annually.

4. A farmer bought a tractor costing ₱ 25,000 payable in 10 semi-annual payments, each

installment payable at the beginning of each period. If the rate of interest is 26% compounded
semi-annually, determine the amount of each installment.

5. An equipment which costs ₱ 40,000 is to be purchased through a series of 10 semi-annual

payments in which the first payment is due 6 months after the equipment is released. The first
6 payments will be ₱6,000 each, while the remaining 4 equal payments will liquidate the
remaining balance. What is the amount of the last 4 payments if the interest rate is 15%
compounded semi-annually?

6. A man deposits ₱ 50,000 in a bank account at 6% compounded monthly for 5 years. If the
inflation rate of 6.5% per year continues for this period, will this effectively protect the
purchasing power of the original principal?

7. A man borrowed a sum of money and promised to pay annually for 8 years at an interest rate
of 12% compounded annually. If the total interest for his debt will be ₱ 185,000 after 8 years,
how much will his annual payments be?

Perpetuity
Perpetuity is a series of uniform cash flows where they extend indefinitely.
P

0 1 2 3 n→∞

A A A
Cash flow diagram to find P given A

A Self-regulated Learning Module 38

From the formula of present worth of an ordinary annuity;
1−(1+i)−n
P=A i

The expression (1 + i)−∞ approaches o when n approaches infinity. Thus, the present worth of perpetuity
becomes;
�
P= �
(Ordinary Perpetuity)
�
P= �
(1 + i)-m (Deferred Perpetuity)
Where :
m = deferred period

Sample Problem
What amount of money invested today at 15% interest can provide the following scholarship: ₱30,000
at the end of each year for 6 years; ₱40,000 for the next years and ₱50,000 thereafter?
Given: F11 - ∞ = ₱50,000
Required:
i = 15%
Present worth, P
F6 = ₱30,000
F10 = ₱40,000
Solution:
�50,000 � �50,000
, 15%, 12
0.15 � 0.15

P40,000(P/A,15%,6)(P/F,15%,6)P40,000(P/A,15%,6)
P50,000 P50,000
P30,000(P/A,15%,6)(P/F, 15%, 6) P40,000P40,000P40,000

P30,000 P30,000 P30,000

0 1 2 6 7 8 12 13 14

Using today as the focal date, the present worth is

�50,000
P = P30,000 (P/A, 15%, 6) + P40,000 (P/A, 15%, 6) (P/F, 15%, 6) + (P/F ,15%, 12)
.15
1−(1+.15)−6 1−(1+.15)−6 �50,000
= P30,000 +P40,000 (1+.15)-6 + .15 (1+.15)-12
.15 .15
�50,000
= P30,000 (3.7845) + P40,000 (3.7845) (0.4323) + (0.1869)
.15
P = P241,477

A Self-regulated Learning Module 39

Capitalized Cost
Capitalized cost is an application for perpetuity. It is one method used in comparing alternatives. It is
defined as the sum of the first cost (FC) and the present worth of all perpetual maintenance and replacement
cost.
Case 1. No replacement, only maintenance and or operation every period.
Capitalized cost = First cost + Present worth of Perpetual operation and/or maintenance.

Where:
FC = first cost (initial investment)
PO&M= Present worth of all perpetual operation and maintenance cost

Sample Problem
Determine the capitalized cost of a structure that requires an initial investment of ₱10,000,000 and an
annual maintenance of ₱950,000. i = 15%

Given:
FC = ₱10,000,000
Annual maintenance = ₱950,000 i = 15%
Solution:
₱950,000 ₱950,000

0 1 2
P

� �950,000
P = = = ₱6,333,334.00
� 0.15

Capitalized cost, CC = First cost + P

= ₱10,000,000 + ₱6,333,334
CC = ₱16,333,334.00

Case [Link] only, no maintenance and/ or operation.

Capitalized cost = First cost + Present worth of perpetual replacement
Let S = amount needed to replace a property every k period
X = amount of principal invested at rate i% the interest on which will
amount to S every k periods
Xi = interest on X every period, the periodic deposit towards

A Self-regulated Learning Module 40

 accumulation of S
S

0 1 2 3 k-1 k

Xi Xi Xi Xi Xi

Cash flow diagram to find X given S

S = Xi (F/A ,i% ,k)

� 1 � �
X= � =
� ,�%,� � (1+�)� −1
�
�
X =
(1+�)� −1

Difference between P and X in a perpetuity

A A A S S S

0 1 2 3 0 1 2 3

P X

� �
P= X =
� (1+�)� −1

P is the amount invested now at i% per period whose interest at the end of every period forever is A
while X is the amount invested now at i% per period whose interest at the end of every k periods forever is S. If
k = 1, then X = F.

Replacement cost
Let: X = present worth of perpetual replacement
S = amount of replacement
K = replacement period or the life of the property

A Self-regulated Learning Module 41

Salvage Value (SV)
 defined as the worth of the property at the end of useful life

Scrap value (SV)

 defined as the worth of the property if disposed of as a junk.

Then the amount needed for replacement will be:

S = FC – SV

Sample Problem
A new engine was installed by a textile plant at a cost of P300,000 and projected to have a useful life of
15 years. At the end of its useful life, it is estimated to have a salvage value of P30,000. Determine its
capitalized cost if interest is 18% compounded annually.

₱30,000 ₱30,000 ₱30,000

0 15 30 45

₱300,000 ₱300,000 ₱300,000 ₱300,000

Cash flow diagram for the engine

₱270,000 ₱270,000 ₱270,000

0 15 30 45

A Self-regulated Learning Module 42

 � �270,000
X = = = P24,604.17
(1+�) −1 (1+0.18)15 −1
�

Capitalized cost = First cost + X

= ₱300,000 + ₱24,604.17
CC = ₱324,604.17

Case 3. Replacement, maintenance and/or operation every period

Capitalized cost = First cost + Present worth of cost of perpetual operation and/ or maintenance +
Present worth of cost of perpetual replacement

Sample Problem
Determine the capitalized cost of a research laboratory which requires P5,000,000 for original
construction; P100,000 at the end of every year for the first 6 years and then P120,000 each year thereafter for
operating expenses, and P500,000 every 5 years for replacement of equipment with interest at 12% per
annum?
Solution:

P120,000 P P120,000
, 12%, 6
.12 F .12

P100,000 (P/A, 12%, 6) P120,000 P120,000P120,000

P100,000P100,000P100,000P100,000P100,000P100,000

0 1 2 3 4 5 6 7 8 9

Let Q = the present worth of cost of perpetual operation

�120,000
Q = P100,000 (P/A, 12%, 6) + (P/F, 12%, 6)
.12
1−(1+.12)−6 �120,000
= P100,000 + (1.12)-6
.12 .12
�120,000
= P100,000 (4.1114) + (0.5066)
.12
Q = P917,740

Replacement:
P500,000 P500,000 P500,000

A Self-regulated Learning Module 43

 0 5 10 15

X
Let X = the present worth of cost of perpetual replacement
� �500,000
X = = = P655,873.88
(1+�)� −1 (1+.12)5 −1
Capitalized cost = First cost + Q + X
= P5,000,000 + P917,740 + P655,873.88
CC = P6,573,613.88

Gradient Series
Gradient series is the series of cash flow where the amounts change every period.

Uniform Arithmetic Gradient

In certain cases, economic analysis problems involve receipts or disbursement that increase or
decrease by a uniform amount each period. For example, maintenance and repair expenses on specific
equipment or property may increase by a relatively constant amount each period. This is known as a uniform
arithmetic gradient.
P = PA ± PG (“+” – increasing; “-“ – decreasing)
-n
1- 1+i
PA = A (P/A, i%, n) = A i
� 1+� � −1 1
PG = G(P/G, i%,n) = −�
� � 1+� �

Some problems involve cash flows that are projected to increase or decrease by a uniform amount
each period, thus constituting an arithmetic sequence of cash flows.

Sample Problem
Engr. Jay wants to marry his girlfriend after 4 years so he invested in a mutual fund that gives 14%
compounded quarterly. If his first deposit is ₱ 10,000 at the end of the first quarter, ₱15,000 at the end of the
2nd quarter and increases by ₱5,000 at the end of every quarter, what is the calculated present worth of the
investment?
Given: G = ₱5,000
i = 14% CQ Required:
Q1 = ₱ 10,000 Present Worth, P
Q2 = ₱ 15,000

A Self-regulated Learning Module 44

Solution:
Cash Flow diagram

P = PA + PG

1 2 3 4 5 14 15 16

₱ 10,000.00
₱ 15,000.00
₱ 20,000.00
₱ 25,000.00
₱ 30,000.00
₱ 75,000.00
₱ 80,000.00
₱ 85,000.00

PA

1 2 3 4 5 14 15 16 +
=

A = ₱ 10,000.00
PG

1 2 3 4 5 14 15 16

G = ₱ 5,000.00
2G 3G 4G
13G
14G
(n-1)G
Using equation of value, “0” as focal date:
P(1 + 0.14)0 = ₱10,000(1 + 0.14)-1 + ₱15,000(1 + 0.14)-2 + ₱20,000(1 + 0.14)-3 + ₱25,000(1 + 0.14)-4 +
₱30,000(1 + 0.14)-5 + …. + ₱85,000 (1 + 0.14)-16
P = ₱ 216,178.93

Geometric Gradient Series

Deposits or payment where there is an increase or decrease by a fixed percentage.
Some problems involve projected cash flow pattern that are changing at an average rate f. each period
Let: f = fixed percentage (increase of decrease)
�1 = the amount of the first cash flow of the series

0
A Self-regulated Learning Module 45
 1 2 3 … n
.

�1 �2 �3
�1 = the amount of first cash flow
�2 = A1 + A1f = A1 (1+f)
�3 = A1 ( 1+f )2
�4 = A1 (1+f) n-1

Getting the present value of each cash flow:

P= A1 (1+i)-1 + A1 (1+F)(1+i)-2 + A1 (1+f)2 (1+i)-3 … + A1 (1+f)n-1 (1+i)-n

Multiply the equivalent by (1+i ):

1+� 1 1+� 2 1+� 3 1+� 4

P=A + + +…
1+� 1+� 1+� 1+�
CONVENIENCE RATE (icr)

1+�
Icr = −1
1+�
1+�
��� − 1
1+�
P=A1 (1+iCR)-1 [(1+iCR)-1 + (1+iCR)-2 + … (1+iCR)-n]

Simplifying:
�1 1+(1+�)�
P= [ ]
(1+�) �

C(1+r)n-1 C(1+r)n-2
C(1+r) 2

C(1+r)
C

0 1 2 3 n-1 n

P F

� 1−� � 1−� �
P = F = C (1+i)n-1
1+� 1−� 1−�

A Self-regulated Learning Module 46

 1+� 1+�
Where: x = where: x =
1+� 1+�
When: x = 1.0 that is i = r when: x = 1.0 that is i = r
��
P =1+� F = Cn (1+i)n-1

Sample Problem1 P1464.1

P1,210 P1,331
P1,000 P1,100

1 2 3 4 5 6 7 8
P=? i=12% , r = 10%

Solution:
1+� 1 + .10 55
x= = =
1+� 1+.12 56
5 55
�1,000 (1− 56)
P = = P4,307.67
1+.12 (1− 55)
56

(1− 55
56
)5
F = P1,000 (1+.12) 5-1
(1.12)3 = P10,665.63
(1− 55
56
)

Sample Problem 2

P10,000
P9,920
P9,126.4 P8,306.29
P7,724.58 P7,106.62

0 1 2 3 4 5 6
i = 10% , r = 8%
P=? F=?

Solution:

A Self-regulated Learning Module 47

 1− � 1− .08 46
x= 1−�
= 1−.10
= 45

6 46
�10,000 (1− 45 )
P = 46 = ₱ 36,540.47
1+.10 (1− )
45
(1− 46
45
)6
F = P10,000 (1+.10) 6-1
= ₱ 64,733.67
(1− 46
45
)

Check for facts – First Grading Activity 4

Problem Solving: See instructions and rubric at the start of this module.

1. A contract has been signed to lease a building at ₱ 20,000 per year with an annual increase of ₱ 1,500
for 8 years. Payments are to be made at the end of each year, starting one year from now. The
prevailing interest rate is 7%. What lump sum paid today would be equivalent to the 8-year lease
payment plan?

2. Find the present value of perpetuity of ₱ 2,000 payable every month. If money is worth 20%
compounded monthly and the first payment starts at the end of 5th month.

3. The first cost of certain equipment bought by Kartahira Construction is Ᵽ324, 000 and has a
salvage value of Ᵽ50, 000 at the end of its life of 4 years. If money is worth 6% annually,
compute:
a. Capitalized cost
b. If there is no salvage value and the annual maintenance cost is Ᵽ18, 000, find the capitalized
cost.

4. The maintenance of room air conditioner is expected to be Ᵽ2, 000 at the end of the first year
and is expected to increase by Ᵽ100 each year for the following 7 years. Assuming rate of
interest is 6%, compute the equivalent uniform annual maintenance cost.

5. It costs ₱ 50,000 at the end of each year to maintain a section of Kennon road in Baguio City. If money
is worth 10%, how much would it pay to spend immediately to reduce the annual cost to ₱ 10,000?

Assessment - First Grading Quiz 3

Problem Solving: See instructions and rubric at the start of this module.

1. Find the present value of perpetuity of ₱ 1,000 payable every month.

a. If money is worth 10% compounded monthly.
b. If money is worth 10% compounded quarterly.
c. If money is worth 10% compounded monthly and the first payment starts at the end of 6th month.

A Self-regulated Learning Module 48

 2. Suppose a man receives an initial annual salary of ₱ 60,000, increasing at the rate of ₱ 5,000 a year. If
money is worth 10%, determine the equivalent uniform salary for a period of 8 years.

3. An equipment has a first cost of ₱ 324,000 and a salvage value of ₱ 50,000 at the end of its life of 4
years. If money is worth 4% compounded annually, find the capitalized cost.

4. A new equipment worth ₱ 500,000 with a salvage value of ₱ 50,000 must be replaced at the end of
each 10 years. If the annual maintenance required is ₱ 10,000, find the capitalized cost if money yields
5%.

5. Deposits are made to an account as indicated in the table below which bears interest at the rate of 10%
compounded annually. How much will there be in the account at the end of the sixth year?

End of Year Deposit

1 ₱0
2 ₱ 500
3 ₱ 1,000
4 ₱ 1,500
5 ₱ 2,000

Lesson 4 – Depreciation

Learning Outcomes:
At the end of the lesson, the students should be able to:
1. Understand the concept and methods of depreciation.
2. Solve engineering problems using the methods of depreciation.

Depreciation
 It is the decrease in the value of physical property with the passage time. (Sta. Maria, H.)

Purpose 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
result from the use of the property. Depreciation cost is deductable in computing profits on which

A Self-regulated Learning Module 49

 income taxes are paid.

Properties Depreciable Assets

1. It must have a determinable life and the life must be greater than 1 year.
2. It must be something used in business or held to produce income.
3. It must not be an inventory or stock in trade or investment.
4. It must be something that useful in production that losses its value due to natural causes, gets used up,
etc.

Types of Depreciation
1. Normal Depreciation
a. Physical – a less in value of a property due to the lessening of the physical ability of a property
to produce results.
Common causes: Wear and deterioration
b. Functional - a less in value of a property due to the lessening in the demand for the function
which the property designed to render.
Common causes: Inadequacy, changes in styles, Efficiency of machine

2. Depreciation due to changes in price levels

3. Depletion – a less in value of a property due to gradual extraction of its contents.

Terminologies in Depreciation:

 Value – the present worth of all future profits that are to be received through ownership of a particular
property.
 Book Value – the original cost basis of the property including any adjustments, less all allowable
depreciation deductions.
 Market Value – the amount paid to a willing seller by a willing buyer of an asset.
 Fair Value – the value which is usually determined by a disinterested third party in order to establish a
fair price to both seller and buyer.
 Salvage Value or Resale Value – the estimated price of the property at the end of its life.
 Scrap Value – the worth of the property as junk
 Usual Life – the number of years as an asset’s recovery
 Utility or Use Value – the worth of the property to the owner as an operating unit
 Recovery period – the anticipated period of a property’s life

Methods in Depreciation
1. Historical Methods
1. The Straight Line Method
2. The Sinking Fund Formula
3. Declining Balance Method
4. Double Declining Balance Method
5. The Sum-of-the-Year’s Digits (SYD) Method

A Self-regulated Learning Module 50

 6. The Service-Output

2. Modified Accelerated Cost Recovery System (MACRS)

A. Historical Methods

1. The Straight Line Method

 It assumes that a constant amount is depreciated each year over the useful life of the
property.

Depreciation per year,

Depreciation at nth year,

Book value at nth year,

Problem: The cost of equipment is Php 500,000 and the cost of installation is Php 30,000. If the salvage value
is 10% of the cost of equipment at the end of 5 years, determine the book value at the end of the fourth year
using the straight line method.

Given:
First Cost, CO= ₱ 500,000 + ₱ 30,000= ₱ 530,000
Salvage value, CL = 0.10 (₱ 500,000) = ₱ 50,000
L = 5 years
Required:
Book Value at the end of 4 years (C4)

Solution:
I. Using Formula
Annual depreciation, d = 530,000 – 50,000
5
d = ₱ 96,000

Total depreciation at the end of fourth year,

D4 = 4 (₱ 96,000) = ₱ 384,000

Book value at the end of fourth year,

C4 = 530,000 – 384,000
C4 = ₱ 146,000.00

II. Using Table

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 YEAR BOOK VALUE AT DEPRECIATION BOOK VALUE AT THE END
THE BEGINNING OF PER YEAR, d OF YEAR (2nd column minus
YEAR, C0 3rd column)

1 Ᵽ 530, 000 Ᵽ 96, 000 Ᵽ 530, 000 - Ᵽ 96, 000 =

Ᵽ 434, 000

2 Ᵽ 434, 000 Ᵽ 96, 000 Ᵽ 434, 000 - Ᵽ 96, 000 =

Ᵽ 338, 000

3 Ᵽ 338, 000 Ᵽ 96, 000 Ᵽ 338, 000 - Ᵽ 338, 000 =

Ᵽ 242, 000

4 Ᵽ 242, 000 Ᵽ 96, 000 Ᵽ 242, 000 - Ᵽ 338, 000 =

Ᵽ 146, 000

2. The Sinking Fund Formula

 It assumes that a sinking fund is established in which funds will accumulate for
replacement.

Sinking fund factor =

Depreciation per year,

Depreciation at nth year,

Book value at nth year,

Problem: A certain machinery costs Php 50,000 last 12 years with a salvage value of Php 5,000. The money
is worth 5%. If the owner decided to sell it after using it for 5 years, what should his price be so that he will not
lose or gain financially in the transaction? Use sinking fund method of depreciation.
Given:
First Cost, Co= Php 50,000
L = 12 years
i = 5%
n = 5 years

Required:
Book Value at the end of 5 years, C5

Solution:
Annual depreciation, d = (50,000 – 5, 000) (0.05) = Ᵽ 2,827.14
(1 + 0.05)12 -1

A Self-regulated Learning Module 52

 Total depreciation at the end of 5 years,
D5 = 2,827.14 [(1+0.05)5 – 1]
0.05
D5 = Ᵽ 15,621.75

Book Value at the end of 5 years,

C5 = 50,000 – 15, 621.75
C5 = Ᵽ 34,378.25

3. Declining Balance Method

 It is also called the constant percentage method or the Matheson Formula.
 It is assumed that the annual cost of depreciation is a fixed percentage of the salvage
value at the beginning of the year.

Depreciation at nth year,

Salvage value,

Rate of depreciation,

Book value at the end of n years,

Problem: A certain office equipment has a first cost of Php 20,000 and a salvage value of Php 1,000 at the
end of 10 years. Determine its book value at the end of 6 years using declining balance method.

Given:
First Cost, Co = Php 20,000
Salvage Value, CL = Php 1,000
L = 10 years
n = 6 years

Required:
Book Value at the end of 6 years, C6
Solution:

I. Using Formula

Rate of Depreciation, = 0.259

Book value at the end of 6 years,

6
�6 = 20000 1 − 0.259
C6 = Ᵽ 3,314.45

A Self-regulated Learning Module 53

 II. Using Table

YEAR BOOK VALUE AT THE DEPRECIATION BOOK VALUE AT THE END

BEGINNING OF YEAR DURING THE YEAR OF YEAR

1 Ᵽ 20,000 Ᵽ 20,000 (0.259) = Ᵽ 20,000 - Ᵽ 5,177.31 =

Ᵽ 5,177.31 Ᵽ 14, 822.69

2 Ᵽ 14, 822.69 Ᵽ 14, 822.69 (0.259) = Ᵽ 14, 822.69 - Ᵽ 3,837.08 =

Ᵽ 3,837.08 Ᵽ 10, 985.61

3 Ᵽ 10, 985.61 Ᵽ 10, 985.61 (0.259) = Ᵽ 10, 985.61- Ᵽ 2,843.80 =

Ᵽ 2,843.80 Ᵽ 8,141.81

4 Ᵽ 8,141.81 Ᵽ 8,141.81 (0.259) = Ᵽ 8,141.81 - Ᵽ 2,107.64 =

Ᵽ 2,107.64 Ᵽ 6,034.17

5 Ᵽ 6,034.17 Ᵽ 6,034.17 (0.259) = Ᵽ 6,034.17 - Ᵽ 1,562.04 =

Ᵽ 1,562.04 Ᵽ 4,472.13

6 Ᵽ 4,472.13 Ᵽ 4,472.13 (0.259) = Ᵽ 4,472.13 - Ᵽ 1,157.68 =

Ᵽ 1,157.68 Ᵽ 3,314.45

4. Double Declining Balance Method (DDB)

 It is similar to double declining balance method except that the rate of depreciation k is
replaced by 2/L.

Depreciation at nth year,

Salvage value,

Book value at the end of n years,

Problem: An equipment costs Php 500,000 and has a salvage value of Php 25,000 after its 25 years of useful
life. Using double declining balanced method, what will be the book value of the equipment at the end of 8
years?
Given:
First Cost, Co = ₱ 500,000
Salvage Value, CL = ₱ 25,000
L = 25 years
n = 8 years
Required:
Book Value at the end of 8 years, C8
Solution:
I. Using Formula
2 2
�= = = 0.08
� 25

A Self-regulated Learning Module 54

 Book value at the end of 8 years,
C8 = ₱ 500,000 (1- 0.08)8
C8 = ₱ 256,609.44

II. Using Table

YEAR BOOK VALUE AT THE DEPRECIATION DURING BOOK VALUE AT THE END
BEGINNING OF YEAR THE YEAR OF YEAR
1 Ᵽ 500,000 Ᵽ 500,000 (0.08) = Ᵽ 500,000 - Ᵽ 40,000 =
Ᵽ 40,000 Ᵽ 460,000.00
2 Ᵽ 460,000 Ᵽ 460,000 (0.08) = Ᵽ 460,000 - Ᵽ 36,800 =
Ᵽ 36,800 Ᵽ 423,200
3 Ᵽ 423,200 Ᵽ 423,200 (0.08) = Ᵽ 423,200- Ᵽ 33,856 =
Ᵽ 33,856 Ᵽ 389,344
4 Ᵽ 389,344 Ᵽ 389,344 (0.08) = Ᵽ 389,344 - Ᵽ 31,147.52 =
Ᵽ 31,147.52 Ᵽ 358,196.48
5 Ᵽ 358,196.48 Ᵽ 358,196.48 (0.08) = Ᵽ 358,196.48 - Ᵽ 28,655.72=
Ᵽ 28,655.72 Ᵽ 329,540.76
6 Ᵽ 329,540.76 Ᵽ 329,540.76 (0.08) = Ᵽ 329,540.76 - Ᵽ 26,363.26 =
Ᵽ 26,363.26 Ᵽ 303,177.50
7 Ᵽ 303,177.50 Ᵽ 303,177.50 (0.08) = Ᵽ 303,177.50 - Ᵽ 24,254.20 =
Ᵽ 24,254.20 Ᵽ 278,923.30
8 Ᵽ 278,923.30 Ᵽ 278,923.30 (0.08) = Ᵽ 278,923.30 - Ᵽ 22,313.86 =
Ᵽ 22,313.86 Ᵽ 256,609.44

5. Sum-of-the-Year’s Digits (SYD) Method

 It is assumed that the tangible properties are usually productive when they are new, and
their use decreases as they become old.
Let:
dn = depreciation charge during the nth year
dn = (depreciation factor)(total depreciation)

Problem: An asset is purchased for Php 9,000. Its estimated life is 10 years, after which it will be sold for Php
1,000. Find the book value at the end of third year if the sum-of-the-years’ digit (SOYD) depreciation is used.

Given:
First Cost, Co = Ᵽ 9, 000
Salvage Value, CL = Ᵽ 1, 000
L = 10 years
n = 3 years

Required:
Book value at the end of 3 years. C3
Solution:

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 I. Using Formula

SYD = 1 + 2 + 3 + 4 + 5 + 6 + 7 + 8 + 9 + 10 = 55

Total depreciation at the end of 3 years,

10+9+8
d3 =
55
₱ 9,000 − ₱1,000 = 3927.27

Book value at the end of 3 years,

C3 = Ᵽ 9,000 - Ᵽ 3,927.27
C3 = Ᵽ 5,072.73

II. Using Table

YEAR BOOK DEPRECIATION DEPRECIATION BOOK VALUE AT

VALUE AT FACTOR DURING THE YEAR THE END OF YEAR
THE
BEGINNING
OF YEAR

1 Ᵽ 9,000 10/55 (Ᵽ 9,000 - Ᵽ1,000)(10/55) Ᵽ 9,000 - Ᵽ 1,454.55

=Ᵽ 1, 454.55 = Ᵽ 7, 545.45

2 Ᵽ 7, 545.45 9/55 (Ᵽ 9,000 - Ᵽ 1,000)(9/55) Ᵽ 7,545.45 - Ᵽ1,309.09

= Ᵽ 1, 309.09 = Ᵽ 6, 236.36

3 Ᵽ 6, 236.36 8/55 (Ᵽ 9,000 - Ᵽ 1,000)(8/55) Ᵽ 6,236.36 - Ᵽ1,163.64

= Ᵽ 1, 163.64 = Ᵽ 5, 072.73

6. Service Output
 It is assumed that the results in the cost basis allocated equally over the output
(produced units) of the property during the period of tangible properties.
Let:
T = total units of output up to the end of life
Qn = total number of units of output during the nth year

Depreciation per hour,

Depreciation in n years,

Problem: A machine costs Php 400,000 with a salvage value of Php 20,000. Life of it is six years. In the first
year, 4,000 hours, in the second year, 6,000 hours and 8,000 hours on the third year. The expected flow of the
machine is 38,000 hours in six years. What is the depreciation at the end of the second year?
Given:

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 First Cost, Co = Ᵽ 400,000
Salvage Value, CL = Ᵽ 20,000
L = 6 years
n = 2 years
T = 38,000 hours
Q2 = 6, 000 hours
Required:
Depreciation at the end of2 years, d2
Solution:
Depreciation per hour = 400,000 – 20,000
38,000
= Ᵽ 10

Depreciation at the end of 2 years,

d2 = (Ᵽ 10) (6,000 hours)
d2 = Ᵽ 60,000

B. Modified Accelerated Cost Recovery System (MACRS)

 It is assumed that the value of asset’s salvage value is equal to zero.

� �
Depreciation at first Year, �� = � �
(�� )

�
Depreciation at nth year, �� = �
�� − �� − ��−�

Problem: The cost of equipment is Ᵽ 500,000 and the cost of installation, labor, taxes and miscellaneous
expenses is Ᵽ30,000. If the salvage value is 10% of the cost of equipment at the end of its life of 5 years,
compute the book value at the end of the 3rd year using the MACRS method.

Given:
First Cost, Co = 500,000 + 30,000 – Php 530,000
L = 5 years
n = 3 years
i = 10%

Required:
Book value at the end of 3 years. C3

Solution:
1st year Depreciation = ½ [2/5 (530,000)] = Ᵽ 106,000

2nd year Depreciation = 2/5 (530,000 – 106,000)

= Ᵽ 169, 600

3rd year Depreciation = 2/5 (530,000 – 106,000 – 169,000)

= Ᵽ 101,760

d3 = ∑d = 106,000 + 169,600 + 101,760 = Ᵽ 377360

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 Book Value at the end of three years,
C3 = Ᵽ 530,000 – Ᵽ 377360
C3 = Ᵽ 152,640.00

Check for facts – Midterm Activity 1

Problem Solving: See instructions and rubric at the start of this module.

1. A contractor imported a bulldozer for his job, paying ₱ 250,000 to the manufacturer. Freight
and insurance charges amounted to ₱ 18,000; customs’, broker’s fees and other services,
₱8,500; taxes, permits, and other expenses, ₱ 25,000. If the contractor estimates the life of the
bulldozer to be 10 years with a salvage value of ₱ 20,000, determine the book value at the end
of 6 years, using the:

a) Straight-line Method
b) Sinking Fund Formula at 8%
c) Sum-of-the-years’ digit Method
d) Declining Balance Method
e) Double Declining Method

2. A telephone company purchased microwave radio equipment for ₱ 6M. if the equipment shall
be depreciated over a period of 8 years with a salvage value of 5% of the cost of the
equipment. Determine the book value at the end of 4 years. Use the Modified Accelerated Cost
Recovery System (MACRS) method.

Assessment – Midterm Quiz 1

Problem Solving: See instructions and rubric at the start of this module.

1. An engineer bought equipment for ₱ 500,000. He spent an additional amount of ₱ 30,000 for
installation and other expenses. The estimated useful life of the equipment is 10 years. The
salvage value is 10% of the first cost. Using the straight line method of depreciation, find the
book value at the end of 4 years.

2. An equipment was bought for ₱ 1,800, 000 with a salvage value of ₱ 350,000 after its life of 8
years. Using the double declining balance method of depreciation, find its book value after 5
years.

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 3. A machine costing ₱ 45,000 is estimated to have a salvage value of ₱ 4,350 when retired at
the end of 6 years. Depreciation cost is computed using a constant percentage of the declining
book value. What is the annual rate of depreciation?

4. An asphalt and aggregate mixing plant having a capacity of 50 m3 every hour costs
₱2,500,000. It is estimated to process 800,000 m3 during its life. During a certain year it
processed 60,000 m3. If its scrap value is ₱ 100,000, determine the total depreciation during
the year and the depreciation cost chargeable to each batch of 50 m3 using the production
units method.

5. The original cost of a certain piece of equipment is ₱ 500,000. The value after its useful life of
5 years is ₱ 100,000. The cost of money is 8% per year. Using the sinking fund method, find
its book value after 3 years.

6. A machine is depreciated using the sum of the years’ digit method. The
Equity totalFinance
Capital depreciation after
12 years is ₱ 16,253,532.67 and the depreciation
Financial
on the 17 th
year is ₱ 541,784.42.
 obtains from selling an Its book
value at the end of the 14th year is ₱ 7,603,291.41. ownership stake
Capital
a. Compute the life of the machine. - refers to the
b. Find the total depreciation of the machine after its life.
money Debt Capital Finance
invested  borrowed from lending
c. Find the first cost of the machine.
companies

7. An earth moving equipment that cost Ᵽ 90,000 will have an estimated salvage value of Ᵽ18,000 at the
end of its life of 8 years. Use modified accelerated cost recovery system (MACRS) method.
a. Determine the total depreciation at the endof
Types of 2nd year.
b. What would be its worth after 3 years?Capital
Human Natural Capital
Capital - refers to the
- refers to the natural
manpower of resources to
an be used in the
organization business

Lesson 5 – Capital Financing

Topics:
Types of Capital
Types of Organization
Capitalization of Corporation
Bond Value

Learning Outcomes:
At the end of the lesson, the students can differentiate the types of organization and able to solve bond
problems.

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 Capital Financing is a way to gain money through investing money in a business. Capital is a term for
financial assets, such as funds held in deposit accounts and funds obtained from special financing sources.

Types of Business Organization

Characteristics / Ownership Rules Personal Liability Tax Treatment
Entities of the Owners
A. Individual a. One owner Unlimited liability Entity not taxed, as the profits
ownership b. Easy to dissolve for his debts and losses are passed through
to the sole proprietor
B. Partnership a. Unlimited number of Each partner has a Entity not taxed as the profits
partners liability for the and losses are passed through
b. Depends on the life of debts to the general partners
the individual partners
C. Corporation a. Unlimited number of no personal liability Corporation taxed on its
shareholder of the shareholders earnings at the corporate level
b. Perpetual life for the obligations and the shareholders have a
of the corporation further tax on any dividends
distributed (“double taxation”)
Entity not taxed, as the profits
and losses are passed through
to the sole proprietor

Characteristics / Legal Requirements Profit and Equity Capital

Entities benefits
A. Individual Few requirements are Unlimited liability Limited
ownership required for his debts

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 B. Partnership Few requirements are Each partner has Limited
required a liability for the
debts
C. Corporation Greater degree of No personal Unlimited
governmental control liability of the
shareholders for
the obligations of
the corporation

Capitalization of a Corporation
A. Capital stocks
Stocks – an equity instrument carrying ownership interest (dividend).
Return of investment: Price change, dividend and interest payments

Types of Capital Stocks

a. Common Stock
Legal right of a stock holder
o Vote stockholder’s meetings.
o Elect directors and delegate them power to conduct the affairs of the business.
o Sell or dissolve the corporation
o Make and amend the by laws of the corporation.
o Subject to government approval, amend or change the charter or capital structure.
o Participate in the profits.
o Inspect the books of the corporation.

b. Preferred Stock - Stockholders are guaranteed a definite dividend on their stock

B. Financing with bonds

Bond – a debt instrument with a promise to pay back the money with interest. It is the issued
certificate of indebtedness. Investors buy these bonds to collect interest that must be paid by the
bond issuer. The interest can be variable or fixed.
Return of investment: Face value and interest

Classification of Bonds
1. Registered Bonds - Doesn’t need action from the holder.
2. Coupon Bonds - Needs to surrender his bond to redeem.

Bond Value
- The value of a bond is the present worth of all future amounts that are expected to be received
through ownership of the bond.

Sample Problem
A bond with a par value of ₱ 1,000 and with a bond rate of 9% payable annually is to be redeemed at ₱
1,050 at the end of 6 years from now. If it is sold now, what should be the selling price to yield 8%.

Given:
F = ₱ 1,000
r = 9%

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 n = 6 years
C = ₱ 1,050
i = 8%
Required:
Selling price before redemption, P
Solution:
Fr = ₱ 1,000 (9%) = ₱ 90.00 ₱ 1,050

₱ 90 ₱ 90 ₱ 90 ₱ 90 ₱ 90
₱ 90

P 1 2 3 4 5 6

I. Using equation of value (“0” as focal point)

P = ₱ 90 (1+ 8%)-1 + ₱ 90 (1+ 8%)-2 + ₱ 90 (1+ 8%)-3 + ₱ 90 (1+ 8%)-4 + ₱ 90 (1+ 8%)-5 + ₱ 90(1+ 8%)-6
+ ₱ 1,050 (1+ 8%)-6
P = ₱ 1,077.74

II. Using Formula

P = (P/Fr,%,n) + (P/C,%,n)

P= + C (1 + i)-n

P= + ₱ 1,050 (1 + 8%)-6

P = ₱ 1,077.74

Check for Facts – Midterm Activity 2

Problem Solving: See instructions and rubric at the start of this module.

1. A bond with a par value of ₱ 1,000 and with a bond rate of 10% payable annually is sold
now for ₱ 1,080. If the yield is to be 12%, how much should the redemption price be at the
end of 8 years?

2. A company has issued 10-year bonds, with a face value of ₱ 1,000,000, in 1,000 units. Interest at
16% is paid quarterly. If an investor desires to earn 20% nominal interest on ₱ 100,000 worth of
these bonds, what would the selling price have to be?

Assessment – Midterm Quiz 2

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 Problem Solving: See instructions and rubric at the start of this module.

1. A man wants to make 14% nominal interest compounded semi0anually on a bond investment.
How much should the man be willing to pay now for a 12% - ₱ 10,000 bond that will mature in
10 years and pays interest semi-annually?

2. A ₱1,500-bond which will mature in 10 years and with a bond rate of 15% payable annually is
to be redeemed at par at the end of this period. If it is sold now for ₱ 1,390, determine the yield
at this price.

3. A Corporation sold an issue of 20-year bonds, having a total face value of 10,000,000 for 9,500,000.
The bonds bear interest at 16%, payable semiannually. The company wishes to establish a sinking
fund for retiring the bond issue and will make semiannual deposit that will earn 12%, compounded
semiannually. Compute the annual cost for interest and redemption of these bonds.

Lesson 6 – Basic Economy Studies Methods

Topics:
Rate of Return (ROR)
Annual Worth (AW)
Present Worth (PW)
Future Worth (FW)
Payback (Payout) Period
Benefit-Cost Ratio

Learning Outcomes:
At the end of the lesson, the students should be able to:
1. Understand the methods in economy studies.

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 2. Evaluate investment based on the condition of basic economy study methods.

Economy studies are necessary to be conducted in order to determine the needed capital investment and
the possibility of the investment to recover over time with an additional return which is called profit.
Basic patterns for making economy studies
1. Rate of Return (ROR)
2. Annual Worth (AW)
3. Present Worth (PW)
4. Future Worth (FW)
5. Payback (Payout) Period

1. Rate of Return (ROR) Method

 Rate of return is a measure of the effectiveness of an investment of capital.
��� ������ ������
Rate of Return = ������� ����������

 INTERNAL RATE OF RETURN - It involves finding the interest rate at which the present worth of the
cash inflow equals the present worth of the cash outflow
 EXTERNAL RATE OF RETURN - It involves finding the interest rate at which the future worth of the
outflows equals the future worth of the inflows.
 EXPLICIT RATE OF RETURN – It involves dividing a net profit amount by the initial investment, where
the net profit is calculated using a depreciation charge based on the sinking fund.

2. Annual Worth (AW)

 As long as the Net Annual Worth (Annual equivalent of inflows minus outflows) is ≥ 0 the
investment is economically justified.
Net Annual Worth = Annual Revenue – Annual Expenses
(+) N.A.W. = Valid investment
(-) N.A.W. = Invalid investment

3. Present Worth (PW)

 As long as the net present worth (present equivalent of cash inflows minus cash outflows) is ≥ 0,
the investment is economically justified.
Net Present Worth = Ʃ PW of cash inflows – Ʃ PW of cash outflow
(+) N.P.W. = Valid investment
(-) [Link]. = Invalid investment

4. Future Worth (FW)

 As long as the net future worth (future equivalent of cash inflows minus cash outflows) is ≥ 0,
the investment is economically justified.
Net Future Worth = Ʃ FW of cash inflows – Ʃ FW of cash outflow
(+) N.F.W. = Valid investment
(-) N.F.W. = Invalid investment

5. Payback Period Method

 It is the length of time required to recover the first cost of an investment from the net cash flow
with an interest rate of zero.
����������−������� �����
Payout period = ��� ������ ���� ����

A Self-regulated Learning Module 64

Procedure of analysis
1. Categorize cost for income/revenue and expenses.
2. Calculate annual revenue and annual expenses separately.
 Make sure to convert all cost per year.
 For ROR and AW method, the same structure in solving for annual revenue and annual
expenses, the only difference is in AW there is an additional annual expense which is “Interest
on Capital”.
 For PW and FW method, use cash flow diagram to represent all inflows and outflows. Recall the
basic concept in Annuity and Compound Interest.
3. Use the formula in the method.
4. Compare the computed value based on the condition of the methods.
5. Make a conclusion.

Sample Problem: A businessman is considering building a 25-unit apartment in a place near a progressive
commercial center. He felt that because of the location of the apartment it will be occupied 90% at all time. He
desires a rate of return of 20%. Other pertinent data are the following:
Land investment ₱ 5,000,000.00
Building Investment ₱ 7,000,000.00
Study period 20 years
Cost of land after 20 years ₱ 20,000,000.00
Cost of building after 20 years ₱ 2,000,000.00
Rent per unit per month ₱ 6,000.00
Upkeep per unit per year ₱ 500.00
Property taxes 1.00% of investment
Insurance 0.50% of investment
Is this a good investment?

Solution:

A. Using Rate of Return (ROR) Method

Rate of Return = Net annual profit

Capital investment

Annual Revenue:
Building rental per year ₱ 6,000.00/[Link]. (25 units)(12 mo.)(90%) = ₱ 1,620,000
Worth of Land = ₱ 80,347.96

***Depreciation using Sinking fund factor (F/A, %, n)

Total = ₱ 1,700,347.96
Annual Costs:
Upkeep/Maintenance of unit ₱ 500.00/unit (25 units) = ₱ 12,500.00
Property tax (Land & Building) 1.00% (₱ 12,000,000.00) = ₱ 120,000.00
Insurance (Building only) 0.50% (₱ 7,000,000.00) = ₱ 35,000.00

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 Depreciation (Building) = ₱ 26,782.65

Total = ₱ 194,282.65
Net Annual Profit = Annual Revenue – Annual Costs
= ₱ 1,700,347.96 - ₱ 194,282.65
Net Annual Profit = ₱ 1,506,065.31

Capital Investment = ₱ 5,000,000 + ₱ 7,000,000 = ₱ 12,000,000.00

Rate of Return = ₱ 1,506,065.31 x 100% = 12.55% < 20%

₱ 12,000,000.00

The computed rate of return is lesser than the desired rate of return, therefore the business is
not a good investment.

B. Using Annual Worth (AW) Method

Net Annual Worth = Annual Revenue – Annual Expenses
Annual Revenue:
Building rental per year ₱ 6,000.00/[Link]. (25 units)(12 mo.)(90%) = ₱ 1,620,000
Worth of Land = ₱ 80,347.96

***Depreciation using Sinking fund factor (F/A, %, n)

Total = ₱ 1,700,347.96
Annual Costs:
Upkeep/Maintenance of unit ₱ 500.00/unit (25 units) = ₱ 12,500.00
Property tax (Land & Building) 1.00% (₱ 12,000,000.00) = ₱ 120,000.00
Insurance (Building only) 0.50% (₱ 7,000,000.00) = ₱ 35,000.00
Depreciation (Building) = ₱ 26,782.65

Interest on capital 20% (₱ 12,000,000.00) = ₱ 2,400,000.00

Total = ₱ 2,594,282.65

Net Annual Worth = ₱ 1,700,347.96 - ₱ 2,594,282.65

Net Annual Worth = (-) ₱ 893,934.69 (Negative sign indicates loss in income)

Since the net annual worth is less than zero, the business is not justified.

C. Using Present Worth (PW) Method

Net Present Worth = Ʃ PW of cash inflows – Ʃ PW of cash outflow
Inflow:
Building rental per year ₱ 6,000.00/[Link]. (25 units)(12 mo.)(90%) = ₱ 1,620,000
Total = ₱ 1,620,000

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Outflow:
Upkeep/Maintenance of unit ₱ 500.00/unit (25 units) = ₱ 12,500.00
Property tax (Land & Building) 1.00% (₱ 12,000,000.00) = ₱ 120,000.00
Insurance (Building only) 0.50% (₱ 7,000,000.00) = ₱ 35,000.00
Total = ₱ 167,500

Cash flow Diagram for INFLOW

₱ 20,000,000 + ₱ 2,000,000
= ₱ 22,000,000.00
Ainflow = ₱ 1,620,000.00

1 2 3 4 5 18 19 20
PW

I. Using Equation of Value (All cash flow going to the right, “0” as focal point)
∑PWinflow = ₱ 1,620,000 (1+20%)-1 + ₱ 1,620,000 (1+20%)-2 + ₱ 1,620,000 (1+20%)-3 + ₱ 1,620,000
(1+20%)-4 + ₱ 1,620,000 (1+20%)-5 + …. + ₱ 23,620,000 (1+20%)-20
∑PWinflow = ₱ 8,462,568.34

II. Using the formula for Annuity and Compound Interest)

∑PWinflow = (P/A,%,n) + (P/F,%,n)

= ₱ 1,620,000.00 + ₱ 22,000,000.00 (1 + 20%)-20

∑PWinflow = ₱ 8,462,568.34

Cash flow Diagram for OUTFLOW

PW

Aoutflow = ₱ 167,500

₱ 5,000,000 + ₱ 7,000,000
= ₱ 12,000,000.00

A Self-regulated Learning Module 67

 I. Using Equation of Value (All cash flow going to the right, “0” as focal point)
∑PWoutflow = ₱ 12,000,000.00 + ₱ 167,500 (1+20%)-1 + ₱ 167,500 (1+20%)-2 + ₱ 167,500 (1+20%)-3
+ ₱ 167,500 (1+20%)-4 + …. + ₱ 167,500 (1+20%)-20
∑PWoutflow = ₱ 12,815,654.61

II. Using the formula for Annuity

∑PWoutflow = P0 + (P/A,%,n)
= ₱ 12,000,000.00 + ₱ 167,500
∑PWoutlow = ₱ 12,815,654.61

Net Present Worth = ₱ 8,462,568.34 - ₱ 12,815,654.61

Net Present Worth = (-) ₱ 4,353,086.27 (Negative sign indicates loss in income)

Since the net present worth is less than zero, the business is not justified.

D. Using Future Worth (FW) Method

Net Future Worth = Ʃ FW of cash inflows – Ʃ FW of cash outflow
Inflow:
Building rental per year ₱ 6,000.00/[Link]. (25 units)(12 mo.)(90%) = ₱ 1,620,000
Total = ₱ 1,620,000

Outflow:
Upkeep/Maintenance of unit ₱ 500.00/unit (25 units) = ₱ 12,500.00
Property tax (Land & Building) 1.00% (₱ 12,000,000.00) = ₱ 120,000.00
Insurance (Building only) 0.50% (₱ 7,000,000.00) = ₱ 35,000.00
Total = ₱ 167,500

Cash flow Diagram for INFLOW

₱ 20,000,000 + ₱ 2,000,000
= ₱ 22,000,000.00

Ainflow = ₱ 1,620,000.00

1 2 3 4 5 18 19 20
FW

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 I. Using Equation of Value (All cash flow going to the right, “20” as focal point)
∑FWinflow = ₱ 1,620,000 (1+20%)20 + ₱ 1,620,000 (1+20%)19 + ₱1,620,000 (1+20%)18 + ₱ 1,620,000
(1+20%)17 + ₱ 1,620,000 (1+20%)16 + …. + ₱ 23,620,000 (1+20%)0
∑FWinflow = ₱ 324,434,559.40

II. Using the formula for Annuity

∑FWinflow = (F/A,%,n) + F20

= ₱ 1,620,000 + ₱ 22,000,000

∑FWinflow = ₱ 324,434,559.40

Cash flow Diagram for OUTFLOW

FW

Aoutflow = ₱ 167,500
₱ 5,000,000 + ₱ 7,000,000
= ₱ 12,000,000.00

I. Using Equation of Value (All cash flow going to the right, “20” as focal point)
∑FWoutflow = ₱ 12,000,000 (1+20%)20 + ₱ 167,500 (1+20%)19 + ₱ 167,500 (1+20%)18 + ₱ 167,500
(1+20%)17 + ₱ 167,500 (1+20%)16 + …. + ₱ 167,500 (1+20%)0
∑FWoutflow = ₱ 491,321,439.00

II. Using the formula for Annuity and Compound Interest

∑FWoutflow = (F/P,%,n) + (F/A,%,n)
= ₱ 12,000,000 (1+20%)20 + ₱ 167,500

∑FWoutlow = ₱ 491,321,439.00

Net Future Worth = ₱ 324,434,559.40 - ₱ 491,321,439.00

Net Future Worth = (-) ₱ 166,886,879.60 (Negative sign indicates loss in income)

Since the net future worth is less than zero, the business is not justified.

E. Payback Period Method

Payout period = Investment – Salvage value
Net annual cash flow

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Inflow:
Building rental per year ₱ 6,000.00/[Link]. (25 units)(12 mo.)(90%) = ₱ 1,620,000
Total = ₱ 1,620,000

Outflow:
Upkeep/Maintenance of unit ₱ 500.00/unit (25 units) = ₱ 12,500.00
Property tax (Land & Building) 1.00% (₱ 12,000,000.00) = ₱ 120,000.00
Insurance (Building only) 0.50% (₱ 7,000,000.00) = ₱ 35,000.00
Total = ₱ 167,500

Net annual cash flow = ₱ 1,620,000 - ₱ 167,500

Net annual cash flow = ₱ 1,452,500

Capital Investment = ₱ 5,000,000 + ₱ 7,000,000

Capital Investment = ₱ 12,000,000.00

Salvage Value = ₱ 20,000,000 + ₱ 2,000,000

Salvage Value = ₱ 22,000,000

Payout period = ₱ 12,000,000 - ₱ 22,000,00 = (-) 6.88 years

₱ 1,452,500

The use of payback period for making investment decisions should be avoidedas it may
produce misleading results.

F. Benefit-Cost Ratio

Benefit-cost Ratio is method used to determine the relationship between the costs and the benefit of a
certain project. It can be computed by:

������� − ����������
BCR = ����

RANGE VALUE OF BENEFIT- INTERPRETATION

COST RATIO
BCR < 1 Investment option
generated losses.
BCR = 1 Investment option is neither
profitable or loss.
BCR > 1 Investment option is
profitable.

o For alternative comparison using Benefit/cost Analysis, the benefit and costs used will be the
differences among the alternatives.

Components of Benefit-cost Ratio

1. Benefit
 These are advantages to the project owner expressed in pesos.

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 2. Disbenefit
 These are disadvantages to the project owner expressed in pesos.
3. Cost
 These are the common expenses for the operation of the project.
 Examples: Maintenance cost, Material Cost, Labor Cost, etc.

Advantages of Benefit-cost Analysis

 The method translates the absolute amounts of benefits and costs in ratio.
 It facilitates the comparison between different alternatives.
 The ratio helps interpret the inherent riskiness of a forecasted net cash flows and profitability.
 It considers the value of cash flows in relation to the time of their occurrence.

Disadvantages of Benefit-cost Analysis

 The method alone does not indicate the liquidity/funding aspects of the analyzed options.
 It subjects to various assumptions for the discount rate, residual value and cash flow forecast.

Sample Problem
Determine the B/C ratio for the following project:
First Cost ₱ 100,000
Project Life 5
Salvage Value ₱ 10,000
Annual Benefits ₱ 60,000
Annual O and M ₱ 22,000
Interest rate 15%
Solution:
A. Using Annual Cost Method
Annual Benefit = ₱ 60,000

Annual Cost:
₱100,000−₱10,000
Depreciation 1+15% 5 −1
= ₱13,348.40
15%
Annual O and M =₱22,000.00
Interest on Capital ₱ 100,000 (15%) = ₱ 15,000.00
Total = ₱ 50,348.40

Benefit−Disbenefit ₱ 60,000
BCR = Cost
= ₱ 50,348.40 = 1.19> 1.0

The investment is profitable, since BCR is greater than 1.

B. Using Equivalent Uniform Annual Cost

Cash flow diagram for annual benefit

1 2 3 4 5

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 EUACB = ₱ 60,000

Cash flow Diagram for annual cost

₱ 10,000.00
1 2 3 4 5

A = ₱ 22,000.00
₱ 100,000.00

Convert to
1 2 3 4 5

EUACD
Using the formula for Annuity
EUACD= (A/P,%,n) + A- (A/F,%,n)
15% 15%
= ₱ 100,000 −5 + ₱ 22,000 - ₱ 10,000
1 − 1 + 15% 1+15% 5 −1

EUACD = ₱ 50,348.40

Benefit−Disbenefit ₱ 60,000
BCR = Cost
= ₱ 50,348.40 = 1.19 > 1.0

The investment is profitable, since BCR is greater than 1.

Check for facts – Midterm Activity 3

Problem Solving: See instructions and rubric at the start of this module.
1. A fixed capital investment of ₱ 10,000,000.00 is required for a proposed manufacturing plant and an
estimated working capital of ₱2,000,000.00. Annual depreciation is estimated to be 10% of the fixed
capital investment. Determine the rate of return on the total investment and the payout period if the
annual profit is ₱ 2,500,000.00.

2. A food processing plant consumed 600,000 kW of electric energy annually and pays an average of ₱
2.00 per kWh. A study is being made to generate its own power to supply the energy required in the

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 food processing plant, and that the power plant installation would cost ₱ 2,000,000.00. Annual
operation and maintenance is ₱ 800,000, other expenses costs ₱ 100,000 per year. Life of power plant
is 15 years; salvage value at the end of life is ₱ 200,000; annual taxes and insurances, 6% of first cost;
and rate of interest is 15%. Determine if the power plant is justifiable using:
a. Rate of Return Method
b. Annual Worth Method
c. Present Worth Method
d. Future Worth Method

Assessment – Midterm Quiz 3

Problem Solving: See instructions and rubric at the start of this module.

1. A company is considering equipment A as a replacement for old equipment. Pertinent date are
as follows: first cost = ₱ 200,000, annual operating cost = ₱ 32,000, annual labor cost = ₱
50,000, insurance and taxes = 3%, payroll taxes 4%, estimated life = 10 years, estimated
annual income = ₱ 135,500, interest rate = 15%. Determine if the equipment A is a good
investment using:
a. Rate of Return Method
b. Annual Worth Method
c. Present Worth Method
d. Future Worth Method

2. The Department of Public Works and Highways (DPWH) is considering the construction of a
new highway through a scenic rural area. The road is expected to cost ₱ 50 million with annual
use estimated at ₱ 400,000. The improved accessibility is expected to result in additional income
from tourists of ₱ 7 million per year. The road is expected to have a useful life of 25 years. If the
rate of interest is 15%, should the road be constructed? Use benefit-cost analysis.

Lesson 7 – Decisions under Certainty

Topics:
Comparing Alternatives
Replacement Studies
Break-even Analysis

Learning Outcomes:
At the end of the lesson, the students can apply the methods of economic studies to evaluate
alternatives under certainty condition.

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Engineering Economic Decisions
 It is the process of selecting suitable alternative courses of action relating to engineering projects.

Types of Engineering Economic Decisions

1. Service improvement
2. Equipment and process selection
3. Equipment replacement
4. New Product and Product Expansion

Steps to Rational Decision-making

1. Recognize a decision problem
2. Define the objectives
3. Collect all the relevant information
4. Identify the set of feasible alternatives
5. Select decision criterion to use
6. Select the best alternatives

All the information

needed is fully
available.

Good information
is available.

Information is
incomplete.

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 I. Decision making under Certainty

Comparing Alternatives
A. Evaluation of Mutually Exclusive Alternatives
In this evaluation, the alternatives have common characteristics (having costs and/or revenues) and
only one alternative will govern. As soon as the best alternative is identified, all of the others are
automatically excluded.
Basic Philosophy
The method that requires the minimum investment of capital will produce satisfactory functional results
and will always be used unless there are definite reasons why an alternative requiring a larger investment
should be adopted.
Methods/ Patterns in comparing alternatives
1. Rate of Return on Additional Investment Method
2. Annual Cost (AC) Method
3. Equivalent Uniform Annual Cost (EUAC) Method
4. Present Worth Cost (PWC) Method
5. Capitalized Cost
6. Payback (Payout) Period Method
7. Benefit-Cost Ratio

1. Rate of Return on additional Investment Method

If the rate of return on additional investment is satisfactory, then the alternative requiring a bigger
investment is more economical and should be chosen.
ROR on additional investment = Annual net savings
Additional investment

2. Annual Cost (AC) Method

The method with the least annual cost will be chosen. (Includes depreciation and Interest on
Investment)

3. Equivalent Uniform Annual Cost (EUAC) Method

The method with the least equivalent uniform annual cost is preferred. (Convert all cash flows into
uniform annual cost each year.)

4. Present Worth Cost (PWC) Method

The method with the least present worth cost will be chosen. (Determine the present worth of the
net cash outflows at each period.)

5. Capitalized Cost Method

The method with the least capitalized cost will be chosen. (Determine the total capitalized cost of all
alternatives)

6. Payback Payout Period Method

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 The method with the shortest payback period is used.

7. Benefit Cost Ratio

If BCR > 1.0, use the first alternative.

Procedure of analysis
1. Calculate annual expenses of each alternative.
 Make sure to convert all cost per year.
 Use cash flow diagram for EUAC and PWC.
2. Compare the annual cost based on the condition of each method.
3. Make a conclusion.

Sample Problem: It is proposed to place a cable on an existing pole line along the shore of a lake to connect
two points on opposite sides. The lifespan of cable is 15 years.

LAND SUBMARINE
ROUTE ROUTE
Length, miles 10 5
First Cost of cable per mile ₱ 40, 000 ₱ 68, 000
Annual maintenance per mile ₱ 950 ₱ 3, 500
Interest on Investment 18% 18%
Taxes 3% 3%
Net Salvage Value per mile ₱ 12, 000 ₱ 22, 000

Which is more economical?

Solution:
Step 1: Recognize a decision problem
Placement of cable on two opposite points

Step 2: Define the objectives

To select the cheaper route

Step 3: Collect all the relevant information

Cost are given in the table above

Step 4: Identify the set of feasible alternatives

Land route vs. Submarine route

Step 5: Select decision criterion to use

Refer on the criterion of each method below for the calculation

Step 6: Select the best alternatives

Calculate and make conclusion. (Highlighted with yellow color)

A. Using Rate of Return on Additional Investment Method

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 ROR on additional investment = Annual net savings
Additional investment

For Land Route

First Cost of cable =₱ 40, 000/mile x 10 mile = ₱ 400,000.00
Salvage Value of cable =₱ 12, 000/mile x 10 mile = ₱ 120,000.00

Annual Costs:
Maintenance of cable ₱ 950/mile(10 mile) = ₱ 9,500.00
Tax 3% (₱ 40,000.00x 10 mile) = ₱ 12,000.00
Depreciation ₱400,000 − ₱120,000 = ₱ 4,592.78
1+18% 15 −1
18%
Total = ₱ 26,092.78
For Submarine Route
First Cost of cable =₱ 68, 000/mile x 5 mile = ₱ 340, 000.00
Salvage Value of cable =₱ 22, 000/mile x 5 mile = ₱ 110, 000.00

Annual Costs:
Maintenance of cable ₱ 3,500/mile (5 mile) = ₱ 17,500.00
Tax 3% (₱ 68,000.00 x 5 mile) = ₱ 10,200.00
Depreciation ₱340,000 − ₱110,000 = ₱ 3,772.64
1+18% 15 −1
18%
Total = ₱ 31,472.64

ROR on additional investment =₱ 31,472.64 - ₱ 26,092.78 x 100%= 8.97%< 18%

₱ 400,000 – ₱ 340,000

Since the computed ROR on the additional investment does not satisfy the given rate of
return, then the lower capital should be chosen which is the Submarine route with
₱340,000 investment.

B. Using Annual Cost (AC) Method

For Land Route

First Cost of cable =₱ 40, 000/mile x 10 mile = ₱ 400,000.00
Salvage Value of cable =₱ 12, 000/mile x 10 mile = ₱ 120,000.00

Annual Costs:
Maintenance of cable ₱ 950/mile (10 mile) = ₱ 9,500.00
Tax 3% (₱ 40,000.00x 10 mile) = ₱ 12,000.00
₱400,000 − ₱120,000
Depreciation = ₱ 4,592.78
1+18% 15 −1
18%
Interest on Capital 18%(₱ 400,000) = ₱ 72,000.00
Total = ₱ 98,092.78
For Submarine Route

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 First Cost of cable =₱ 68, 000/mile x 5 mile = ₱ 340, 000.00
Salvage Value of cable =₱ 22, 000/mile x 5 mile = ₱ 110, 000.00

Annual Costs:
Maintenance of cable ₱ 3,500/mile (5 mile) = ₱ 17,500.00
Tax 3% (₱ 68,000.00 x 5 mile) = ₱ 10,200.00
Depreciation ₱340,000 − ₱110,000 = ₱ 3,772.64
1+18% 15 −1
18%
Interest on Capital 18%(₱ 340,000) = ₱ 61,200.00
Total = ₱ 92,672.64

Annual CostA> Annual CostB

The submarine route should be chosen since it is more economical by ₱ 5,420.14.

C. Using Equivalent Uniform Annual Cost (EUAC) Method

For Land Route

First Cost of cable =₱ 40, 000/mile x 10 mile = ₱ 400,000.00
Salvage Value of cable =₱ 12, 000/mile x 10 mile = ₱ 120,000.00

Annual Costs:
Maintenance of cable ₱ 950/mile (10 mile) = ₱ 9,500.00
Tax 3% (₱ 40,000.00x 10 mile) = ₱ 12,000.00
Total = ₱ 21,500.00

Cash flow Diagram

₱ 120,000.00

1 2 3 4 5 13 14 15

A = ₱ 21,500.00

₱ 400,000.00
Convert to
1 2 3 4 5 13 14 15

EUACA
Using the formula for Annuity
EUACA= (A/P,%,n) + A+ (A/F,%,n)
18% 18%
1 − 1 + 18% −15 1 + 18% 15 − 1
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 = ₱ 400,000 + ₱ 21,500 - ₱ 120,000.00

EUACA= ₱ 98,092.78

For Submarine Route

First Cost of cable =₱ 68, 000/mile x 5 mile = ₱ 340, 000.00
Salvage Value of cable =₱ 22, 000/mile x 5 mile = ₱ 110, 000.00

Annual Costs:
Maintenance of cable ₱ 3,500/mile (5 mile) = ₱ 17,500.00
Tax 3% (₱ 68,000.00 x 5 mile) = ₱ 10,200.00
Total = ₱ 27,700.00
Cash flow Diagram
₱ 110,000.00

1 2 3 4 5 13 14 15

A = ₱ 27,700.00

₱ 340,000.00

Convert to
1 2 3 4 5 13 14 15

EUACB
Using the formula for Annuity
EUACB= (A/P,%,n) + A+ (A/F,%,n)
18% 18%
= ₱ 340,000 + ₱ 27,700 - ₱ 110,000.00
1 − 1 + 18% −15 1 + 18% 15 − 1
EUACB = ₱ 92,672.64
EUACA> EUACB
The submarine route should be chosen since it has a lesser EUAC.

D. Using Present Worth Cost (PWC) Method

For Land Route

First Cost of cable =₱ 40, 000/mile x 10 mile = ₱ 400,000.00
Salvage Value of cable =₱ 12, 000/mile x 10 mile = ₱ 120,000.00

Annual Costs:
Maintenance of cable ₱ 950/mile (10 mile) = ₱ 9,500.00

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 Tax 3% (₱ 40,000.00x 10 mile) = ₱ 12,000.00
Total = ₱ 21,500.00
Cash flow Diagram
₱ 120,000.00

1 2 3 4 5 13 14 15

A = ₱ 21,500.00

₱ 400,000.00

(i) Using equation of value (“0” as focal point)

∑PWCA = ₱ 400,000(1+18%)0 + ₱21,500(1+18%)-1 + ₱21,500(1+18%)-2 +
₱21,500(1+18%)-3 + …. + ₱21,500(1+18%)-15 -₱120,000(1+18%)-15
∑PWCA = ₱ 499,446.99

(ii) Using the formula for Annuity and Compound Interest

∑PWCA= P0+ (P/A,%,n)-(P/F,%,n)
−15
1 − 1 + 18%
= ₱ 400,000 + ₱ 21,500 - ₱ 120,000.00(1+18%)-15
18%
∑PWCA = ₱ 499,446.99

For Submarine Route

First Cost of cable =₱ 68, 000/mile x 5 mile = ₱ 340, 000.00
Salvage Value of cable =₱ 22, 000/mile x 5 mile = ₱ 110, 000.00

Annual Costs:
Maintenance of cable ₱ 3,500/mile (5 mile) = ₱ 17,500.00
Tax 3% (₱ 68,000.00 x 5 mile) = ₱ 10,200.00
Total = ₱ 27,700.00

Cash flow Diagram

₱ 110,000.00

1 2 3 4 5 13 14 15

A = ₱ 27,700.00

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₱ 340,000.00

(i) Using equation of value (“0” as focal point)

∑PWCB = ₱ 340,000(1+18%)0 + ₱27,700(1+18%)-1 + ₱27,700(1+18%)-2 +
₱27,700(1+18%)-3 + …. + ₱27,700(1+18%)-15 - ₱110,000(1+18%)-15
∑PWCB = ₱ 471,849.93

(ii) Using the formula for Annuity and Compound Interest

∑PWCB= P0+ (P/A,%,n)- (P/F,%,n)
1 − 1 + 18% −15
= ₱ 340,000 + ₱ 27,700 - ₱ 110,000.00(1+18%)-15
18%
∑PWCB = ₱ 471,849.93

PWCA> PWCB
The submarine route should be chosen since it has a lesser present worth cost.

E. Capitalized Cost Method

CC = FC + PWC + X

For Land Route

First Cost of cable =₱ 40, 000/mile x 10 mile = ₱ 400,000.00
Salvage Value of cable =₱ 12, 000/mile x 10 mile = ₱ 120,000.00

Maintenance of cable ₱ 950/mile (10 mile) = ₱ 9,500.00

Tax 3% (₱ 40,000.00x 10 mile) = ₱ 12,000.00
Total = ₱ 21,500.00
� ₱21,500
PWC = i = = ₱ 119,444.44
18%

� ₱ 400,000 − ₱ 120,000 = ₱ 25,515.44

X= =
1+� �−1 1 + 18% 15 − 1

CCA = ₱ 400,000 + ₱ 119,444.44 + ₱ 25,515.44

CCA = ₱ 544,959.88

For Submarine Route

First Cost of cable =₱ 68, 000/mile x 5 mile = ₱ 340, 000.00
Salvage Value of cable =₱ 22, 000/mile x 5 mile = ₱ 110, 000.00

Maintenance of cable ₱ 3,500/mile (5 mile) = ₱ 17,500.00

Tax 3% (₱ 68,000.00 x 5 mile) = ₱ 10,200.00
Total = ₱ 27,700.00
�
PWC = = ₱27,700 = ₱ 153,888.89
i 18%

� ₱ 340,000 − ₱ 110,000
1+� �−1 1 + 18% 15 − 1
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X= = = ₱ 20,959.11

CCA = ₱ 340,000 + ₱ 153,888.89 + ₱ 20,959.11

CCA = ₱ 514,848.00

CCA> CCB
The submarine route should be chosen since it has a lesser capitalized cost.

Sample Problem 2
Two routes are under consideration for a new highway. Route A would be located about five miles from
the central business district and would require longer travel distances by local commuter traffic. Route B would
pass directly through the down town 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 routes are as follows:
Route A Route B
Initial Cost ₱ 200,000,000 ₱ 250,000,000
Maintenance per year ₱ 700,000 ₱ 1,100,000
Road-user cost per year ₱ 10,000,000 ₱ 4,000,000

If the roads are assumed to last 30 years with no salvage value, which route should be accepted on the
basis of a benefit/cost analysis using an interest rate of 15%.

Solution:
A. Using Annual Cost Method

For Route A
Annual Benefit = ₱ 10,000,000

Annual Cost:
₱ 200,000,000
Depreciation 1+15% 30−1
= ₱460,039.64
15%
Maintenance = ₱700,000.00
Interest on Capital ₱ 200,000,000(15%) = ₱30,000,000.00
Total = ₱ 31,160,039.64

For Route B
Annual Benefit = ₱ 4,000,000

Annual Cost:
₱ 250,000,000
Depreciation 1+15% 30 −1
= ₱575,049.55
15%
Maintenance = ₱1,100,000.00
Interest on Capital ₱ 250,000,000 (15%) = ₱ 37,500,000.00
Total = ₱ 39,175,049.55

Incremental annual benefit = ₱ 10,000,000 - ₱ 4,000,000

Incremental annual benefit = ₱ 6,000,000

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Incremental annual cost = ₱ 39,175,049.55- ₱ 31,160,039.64
Incremental annual cost = ₱ 8,015,009.91

Benefit−Disbenefit ₱ 6,000,000
BCR = Cost
= ₱ 8,015,009.91 = 0.75

Route A should be selected for construction.

B. Using Equivalent Uniform Annual Cost

For Route A
Cash flow diagram for annual benefit

1 2 3 4 5

EUACA = ₱10,000,000
Cash flow Diagram for annual cost

1 2 3 4 5

A = ₱ 700,000
₱ 200,000,000

Convert to
1 2 3 4 5

EUACA
Using the formula for Annuity
EUACA= (A/P,%,n) + A 15%
= ₱ 200,000,000 + ₱ 700,000
1 − 1 + 15% −30
EUACA = ₱ 31,160,039.64

For Route B
Cash flow diagram for annual benefit

1 2 3 4 5

EUACB = ₱4,000,000

Cash flow Diagram for annual cost

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 1 2 3 4 5

A = ₱ 1,100,000
₱ 250,000,000

Convert to
1 2 3 4 5

EUACB
Using the formula for Annuity
EUACB = (A/P,%,n) + A 15%
= ₱ 250,000,000 −30 + ₱ 1,100,000
1 − 1 + 15%
EUACB = ₱ 39,175,049.55

Incremental annual benefit = ₱ 10,000,000 - ₱ 4,000,000

Incremental annual benefit = ₱ 6,000,000

Incremental annual cost = ₱ 39,175,049.55- ₱ 31,160,039.64

Incremental annual cost = ₱ 8,015,009.91

Benefit−Disbenefit ₱ 6,000,000
BCR = Cost
= ₱ 8,015,009.91 = 0.75

Route A should be selected for construction.

B. Evaluation of Independent Projects

In this evaluation, the alternatives would only compared by their minimum acceptable rate of return (MARR)
not against other alternative. Therefore, any rate of return lower than the minimum will not be accepted.

Check for facts – Final Grading Activity 1

Problem Solving: See instructions and rubric at the start of this module.

1. In building their plant, the officers of the International Leather Company had the choice
between alternatives:
One alternative is to build in Metro Manila where the plant would cost ₱ 2,000,000. Labor would
cost annually ₱ 120,000 and annual overhead ₱ 40,000. Taxes and insurance would total 5% of the
first cost of the plant.
Second alternative would be to build in Bulacan a plant costing ₱ 2,250,000. Labor would cost
annually ₱ 100,000 and overhead would be ₱ 55,000. Taxes and insurance would be 3% of the first

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 cost. The cost of raw materials would be the same in either plant. If capital must be recovered within 10
years and money is worth at least 20%, which site should the officers of the company choose? Use the
following method:
a. Rate of Return on Additional Investment Method
b. Annual Cost (AC) Method
c. Equivalent Uniform Annual Cost (EUAC) Method
d. Present Worth Cost (PWC) Method
e. Capitalized Cost Method

Assessment – Final Grading Quiz 1

Problem Solving: See instructions and rubric at the start of this module.
1. Data for two alternatives are as follows:
A B
Investment ₱ 35,000 ₱ 50,000
Annual benefits ₱ 20,000 ₱ 25,000
Annual O and M ₱ 6,450 ₱ 13,830
Estimated life, years 4 8
Net Salvage value ₱ 3,500 0

Using an interest rate of 20%, which alternative should be chosen?

a. Equipment A has a first cost of ₱ 50,000, salvage value of ₱ 2,000, annual maintenance of ₱ 6,000,
and an economic life of 5 years. Equipment B has a first cost of ₱ 150,000, salvage value of ₱ 6,000,
annual maintenance of ₱ 3,000, and an economic life of 15 years. The maximum rate of return for both
equipments is 12% annually.
a. Find the annual cost of equipment A
b. Find the present worth of equipment B.
c. Find the rate of return for the additional investment on equipment B.

b. An electric cooperative is considering the use o f a concrete electric pole in the expansion of its power
distribution lines. A concrete pole costs 18,000 each and will last 20 years. The company is presently
using creosoted wooden poles which cost 12,000 per pole and will last 10 years. If money is worth 12
percent, which ole should be used? Assume annual taxes amount to 1 percent of first cost and zero
salvage value in both cases. Determine the best alternative using: (i = 12%)
a. Rate of Return on Additional Investment Method
b. Annual Cost (AC) Method
c. Equivalent Uniform Annual Cost (EUAC) Method
d. Present Worth Cost (PWC) Method
Replacement analysis
 It is a method of capital budgeting which involves analyzing effectively whether to replace an existing
asset (the defender) with a new one (the challenger).This aims to maximize the profit or minimize the
costs for a certain production.

Four major reasons for replacement

1. Physical Impairment
 This may cause by overusing the asset which turns to function unsatisfactorily.

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 2. Inadequacy
 This may cause due to insufficient capacity to produce the present demand.

3. Obsolescence
 This may cause either by lessening the demand for rendering the service or the availability of
more efficient asset with lower operational cost.

4. Rental or lease possibilities

 This may cause if the investment is too high hence the purpose of use is just limited.

Patterns for Replacement Studies

Basically, the methods in the previous modules can be used in the replacement analysis but the
following are the most common method:
o Rate of Return Method
o Annual Cost Method
o Equivalent Uniform Annual Cost Method

Procedure of analysis
1. Calculate annual costs of each alternative.
 Make sure to convert all costs per year.
 Use cash flow diagram for EUAC.
2. Compare the annual cost based on the condition of each method. (See Module 4)
3. Make a conclusion.

Sample Problem 1
A decision must be made whether to replace a certain engine with a new one, or to rebore the cylinder
of the old engine and thoroughly recondition it. The original cost of the old engine 10 years ago was ₱ 70,000;
to rebore and recondition it now will cost ₱ 28,000, but would extend its useful life for 5 years.
A new engine will have a first cost of ₱ 62,000 and will have an estimated life of 10 years. It is expected
that the annual cost of fuel and lubricants with the reconditioned engine will be about ₱ 20,000 and that this
cost will be 15% less with the new engine. It is also believed that repairs will be ₱ 2,500 a year less with the
new engine than with the reconditioned one. Assume that neither engine has any net realizable value when
retired. If money is worth 16%, what would you recommend?

Solution:
A. Using Rate of Return on Additional Investment
For Reconditioned engine:
Annual Cost:
₱ 28,000
Depreciation 1+16% 5 −1
= ₱ 4,071.46
16%
Fuel and lubricants = ₱ 20,000.00
Repairs = ₱ 2,500.00
Total Annual Cost = ₱ 26,571.46

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For New engine:
Annual Cost:
₱ 62,000
Depreciation 1+16% 10 −1
= ₱ 2,907.87
16%
Fuel and lubricants ₱ 20,000(100%-15%)= ₱ 17,000.00
Total Annual Cost = ₱19,907.87

₱ ��,���.��−₱ ��,���.��
ROR on additional investment = ₱ 62,000− ₱ 28,000
= 19.60%> 16%

Since the computed ROR on the additional investment is greater than the given rate of return,
then higher investment should be chosen which is the New engine.

B. Using Annual Cost

For Reconditioned engine:
Annual Cost:
₱ 28,000
Depreciation 1+16% 5−1
= ₱ 4,071.46
16%
Fuel and lubricants = ₱ 20,000.00
Repairs = ₱ 2,500.00
Interest on Capital ₱ 28,000(16%)= ₱ 4,480.00
Total Annual Cost = ₱31,051.46
For New engine:
Annual Cost:
₱ 62,000
Depreciation 1+16% 10 −1
= ₱ 2,907.87
16%
Fuel and lubricants ₱ 20,000 (100%-15%)= ₱ 17,000.00
Interest on Capital ₱ 62,000(16%)= ₱ 9,920.00
Total Annual Cost = ₱29,827.87

Annual Cost for Reconditioned > Annual Cost for New

Since the annual cost for new engine is more economical than the reconditioned engine, then
the engine should be replaced.

C. Using Equivalent Uniform Annual Cost

For Reconditioned engine:

Annual Costs:
Fuel and lubricants = ₱ 20,000.00
Repairs = ₱ 2,500.00
Total = ₱ 22,500.00

Cash flow Diagram

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 1 2 3 4 5

A = ₱ 22,500.00
₱ 28,000.00

Convert to
1 2 3 4 5

EUACA
Using the formula for Annuity
EUACA= (A/P,%,n) + A
16%
= ₱ 28,000 + ₱ 22,500
−5
1 − 1 + 16%
EUACA = ₱ 31,051.46

For New engine:

Annual Cost:
Fuel and lubricants ₱ 20,000(100%-15%)= ₱ 17,000.00
Total Annual Cost = ₱ 17,000.00
Cash flow Diagram

1 2 3 4 5 10

A = ₱ 17,000.00
₱ 62,000.00

Convert to
1 2 3 4 5 10

EUACB
Using the formula for Annuity
EUACB= (A/P,%,n) + A
16%
= ₱ 62,000 −10
+ ₱ 17,000
1 − 1 + 16%
EUACB = ₱ 29,827.87

Since the equivalent uniform annual cost for new engine is more economical than the

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 reconditioned engine, then the engine should be replaced.

Break-even analysis
 It is a method to determine the number of products or services at a stage where income is equal to the
total costs. Hence, there is no gain or loss expected in break-even point.
REVENUE = FIXED COSTs + VARIABLE COST
Components of Break-even Analysis
1. Fixed Cost
 Also called as Overhead Cost
 These costs are directly related to the level of operation.
 Examples: Taxes, Salaries, Energy Cost, etc.
2. Variable Cost
 These costs may increase or decrease the operational cost.
 Examples: Cost of raw materials, Utility cost, etc.

Break-even chart is a graphical representation of break-even analysis. It shows the stage where a
company can get a loss or profit by the number of produced units.

Profit

Break-even point

Loss

Advantages of Break-even Analysis

 It measures the profit and losses at different levels of production and sales.
 It predicts the effect of changes in sales prices.
 It analyzes the relationship between fixed and variable costs.
 It predicts the effect of cost and efficiency changes on profitability.

Disadvantages of Break-even Analysis

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  It assumes prices are constant at all levels of output.
 It assumes production and sales are the same.
 Break-even charts may be time consuming to prepare.
 It can only apply to a single product.

Sample Problem 1
A manufacturer produces certain items at a labor cost of ₱ 315.00 each, material cost of ₱100.00 each
and variable cost of ₱ 3.00 each. If the item has a unit price of ₱ 995.00, how many units must be produced
each month for the manufacturer to break-even if the monthly overhead is ₱ 461,600.00? Present algebraic
and graphical solution.
Given:
Labor Cost = ₱ 315.00
Material Cost = ₱ 100.00
Variable Cost = ₱ 3.00
Unit Price of item = ₱ 995.00
Overhead = ₱ 461,600.00/month
Solution:

Algebraic Solution
Let X = number of produce unit per month

Income = Unit Price (Quantity)

Income = ₱ 995.00X/month

Total Cost per month = Ʃ Expenses = Fixed Cost + Variable Cost

Total Cost per month = ₱ 315.00X + ₱ 100.00X + ₱ 3.00X + ₱ 461,600.00/month
Total Cost per month = ₱ 418.00X + ₱ 461,600.00/month

Break-even point: Income = Total Cost

₱ 995.00X/month = ₱ 418.00X + ₱ 461,600.00/month
X = 800 units

Graphical Solution

Let X = number of produce unit per month

Income = Unit Price (Quantity)

Income = ₱ 995.00X/month

Fixed Cost= ₱ 461,600.00/month

Variable Cost = ₱ 315.00X + ₱ 100.00X + ₱ 3.00X = ₱ 418.00X

Assume values for X and plot:

X-axis: Number of produced units per month
Y-axis: Costs/Income

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 Intersection of Income and Cost line: Break-even point

As we can see on the graph, break-even point is equal to 800 units.

Sample Problem 2
Compute for the number of blocks that an ice plant must be able to sell per month to break-even based
on the following data:
Cost of electricity per block ₱ 20
Tax to be paid per block ₱ 2
Real state tax ₱ 3,500 /month
Salaries and wages ₱ 25,000 /month
Others ₱ 12,000 /month
Selling price of ice ₱ 55 /block

Solution:
Algebraic Solution
Let X = number of produced blocks

Income = Unit Price (Quantity)

Income = ₱ 55 /block X

Total Cost = Ʃ Expenses

Total Cost = ₱ 20X + ₱ 2X + ₱ 3,500 + ₱ 25,000 + ₱ 12,000
Total Cost = ₱ 22X + ₱ 40,500

Break-even point: Income = Total Cost

₱ 55 /block X = ₱ 22X + ₱ 40,500
X = 1,228 units
Graphical Solution
Let X = number of produced blocks

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 Income = Unit Price (Quantity)
Income = ₱ 55 /block X

Fixed Cost = ₱ 3,500 + ₱ 25,000 + ₱ 12,000 =₱ 40,500

Variable Cost = ₱ 20X + ₱ 2X = ₱ 22X

As we can see on the graph, break-even point is approximately 1200 units.

Check for Facts – Final Grading Activity 2

Problem Solving: See instructions and rubric at the start of this module.
1. A small shop in Bulacan fabricates portable threshers for palay producers in the locality. The shop can
produce each thresher at a labor cost of ₱ 1,800. The cost of materials for each unit is ₱ 2,500. The
variable costs amount to ₱ 650 per unit, while fixed charges incurred per annum totals ₱ 69,000. If the
portable threshers are sold at ₱ 7,800 per unit, how many units must be produced and sold per annum
to break-even? Present algebraic solution.

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 2. A recapping plant is planning to acquire a new Diesel generating set to replace its resent unit
which they run during brownouts. The new set would cost ₱ 135,000 with a five (5) year-life,
and no estimated salvage value. Variable cost would be ₱ 150,000 a year.
The old generating set has a book value of ₱ 75,000 and a remaining life of 5 years. Its
disposal value now is ₱ 7,500 but it would be zero after 5 years. Variable operating cost would
be ₱187,500 a year. Money is worth 10%.
Which is profitable, to buy new generator or retain the old set? Support answer using:
a) Rate of return on additional investment
b) Annual Cost Method
c) Equivalent Uniform Annual Cost Method

Assessment – Final Grading Quiz 2

Problem Solving: See instructions and rubric at the start of this module.

1. Determine the break-even point in terms of number of units produced per month using the
following data:
Selling price = ₱ 600.00 /unit
Total overhead expenses = ₱ 428,000 /month
Labor Cost = ₱115.00 /unit
Cost of Materials = ₱ 76.00 /unit
Other variable cost = ₱ 2.32 /unit

2. An existing factory must be enlarged or replaced to accommodate new production machinery.

The structure was built at a cost of ₱ 2.6 million. Its present book value, based on straight line
depreciation is₱ 700,000 but it has been appraised at ₱ 800,000. If the structure is altered, the
cost will be ₱ 1.6 million and its service life will be extended 8 years with a salvage value of ₱
600,000.
A new factory could be purchased or built for ₱ 5.0 million. It would have a life of 20 years and a
salvage value of ₱ 700,000. Annual maintenance of the new building would be ₱ 160,000 compared
with ₱ 100,000 in the enlarged structure. However, the improved layout in the new building would
reduce annual production cost by ₱ 240,000. All other expenses for the new structure are estimated as
being equal. Using an investment rate of 8 percent, determine which is the more attractive investment
for this firm. Use the following method:
a) Annual Cost Method
b) Equivalent Uniform Annual Cost Method

Lesson 8 – Decisions Recognizing Risks

Topics:
Expected Monetary Value of Alternatives
Discounted Decision Tree Analysis

Learning Outcomes:
At the end of the lesson, the students can apply the economic analysis to evaluate alternatives under
risks condition.

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Decision making under Risks

Risk is present when there may be two or more observable values for a parameter and it is possible to
estimate the chance that each value may occur.

Component of Risk Analysis

Probability is a component of risk analysis which means the likelihood of an event to happen. The
following is an example of probability scale:
Likelihood Description
Relative Numerical
Very Low 0.1 High unlikely to occur
Low 0.3 Unlikely to occur
Moderate 0.5 Possible to occur
High 0.7 Likely to occur
Very High 0.9 High likely to occur

Impact is the effect of the risk event on the project objectives. The following is an example of impact scale:
Objective Relative/Numerical Scale
Very Low / Low / 0.1 Moderate / 0.2 High / 0.4 Very High /
0.05 0.8
Cost Insignificant < 10% 10 – 20% 20– 40% >40%
change in cost increase increase increase increase
Insignificant < 5% 5 – 10% 10 – 20% >20%
Time change in increase increase increase increase
schedule
Barely Minor areas Major areas Unacceptable Project end
Scope noticeable affected affected reduction item
scope effectively
decrease useless
Barely Only Quality Unacceptable Project end
Quality noticeable demanding reduction quality item
quality applications requires sponsor reduction effectively
degradation effected approval useless

A. Expected Monetary Value of Alternatives

An expected monetary value is a mathematical solution for payoffs and probabilities. The goal
of this in decision making is to calculate the governing decision with the highest amount of EMV.
EMV = Probability x Impact

Advantage of Expected Monetary Value

 It gives an average outcome of all identified uncertain events.
 It helps to calculate the contingency reserve.

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  In does not require any costly resources, only experts’ opinions.
 It helps in selecting the best choice in decision tree analysis.

Sample Problem 1
You have identified an opportunity with a 40% chance of happening. However, it may help you gain
₱2,000 if this risk occurs. Calculate the expected monetary value (EMV) for the risk event.

Given:
Probability of risk = 40%
Impact of risk = ₱2,000 (positive impact because of the word “gain”)
Required:
EMV
Solution:
EMV = 0.40 x ₱2,000
EMV = ₱800

Sample Problem 2
During risk management planning, your team has identified three risks with probabilities of 10%, 50%
and 35%. If the first two risks occur, they will cost you ₱5,000 and 8,000; however, the third risk will give you
₱10,000 if it occurs. Determine the expected monetary value of these risk events.

Given:
Probability of risk1 = 10% Impact of risk1 = - ₱5,000 (Cost)
Probability of risk2 = 50% Impact of risk2 = - ₱8,000 (Cost)

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 Probability of risk3 = 35% Impact of risk3 = ₱10,000 (Gain)
Required:
Total EMV
Solution:
EMV1 = 0.10 x (- ₱5,000) = -₱500
EMV2 = 0.50 x (- ₱8,000) = -₱4,000
EMV3 = 0.35 x (₱10,000) = ₱3,500

Total EMV = -₱500 + -₱4,000 + ₱3,500

Total EMV = -₱1,000

B. Discounted Decision Tree Analysis

A decision tree analysis is a graphical representation of alternatives associated with the
possible outcome and risks. The word “tree” diagram signifies the decision points, chance events and
probabilities.

Component of Decision Tree

- Represents decision to be made
- Represents chance events (probability)
- Connect outcomes to the probability outcome
-

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Sample Problem 1
Mary is a manager of a gadget factory. Her factory has been quite successful the past three years. She
is wondering whether or not it is a good idea to expand her factory this year. The cost to expand her factory is
₱ 1.5M. If she does nothing and the economy stays good and people continue to buy lots of gadgets she
expects ₱ 3M in revenue; while only ₱ 1M if the economy is bad. If she expands the factory, she expects to
receive ₱ 6M if economy is good and ₱ 2M if economy is bad.
She assumes that there is a 40% chance of a good economy and a 60% chance of a bad company.

Solution:
Step 1: Draw the decision tree representing the options.

Step 2: Add the chance nodes, the probabilities and the outcomes.

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Step 3: Calculate the expected monetary values.
***Note: Start the calculation from the right.
EMVExpand = 0.40(₱ 6M) = ₱ 2.4M
EMVExpand = 0.60(₱ 2M) = ₱ 1.2M
EMVNo Expand = 0.40(₱ 3M) = ₱ 1.2M
EMVNo Expand = 0.40(₱ 1M) = ₱ 0.6M

Step 4: Calculate the net expected monetary values and interpret the result.
Net EMVExpand = [₱ 2.4M + ₱ 1.2M] - ₱ 1.5M = ₱ 2.1M
Net EMVNo Expand = [₱ 1.2M + ₱ 0.6M] – 0 = ₱ 1.8M
Since ₱ 2.1M > ₱ 1.8M, then Mary should expand the factory.

Check for facts – Final Grading Activity 3

Problem Solving: See instructions and rubric at the start of this module.
A property owner is faced with a choice of:
a. A large-scale investment to improve her flats. This could produce a substantial pay-off in terms of
increased revenue net of costs but will require an investment of 1.4 million pesos. After extensive
market research it is considered that there is a 40% chance that a pay-off of 2.5million will be obtained,
but there is a 60% chance that it will be only 800,000 pesos.
b. A smaller scale project to re-decorate her premises. At 500,000 pesos this is less costly but will
produce a lower pay-off. Research data suggests a 30% chance of a gain of one million pesos but a
70% chance of being only 500,000 pesos.
c. Continuing the present operation without change. It will cost nothing but neither will it produce any pay-
off. Clients will be unhappy and it will become harder to rent the flats out when they become free.
What is the best alternative? Use decision tree analysis.

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Lesson 9 – Decisions under Uncertainty

Topics:
Methods of Decision Making under Uncertainty
Sensitivity Analysis

Learning Outcomes:
At the end of the lesson, the students can apply the concept of economic analysis to evaluate
alternatives under uncertainty condition.

Decisions under Uncertainty

Uncertainty is when there are many unknowns and no possibility of knowing what could occur in the
future to alter the outcome of a decision.

Sources of Uncertainty
1. Possible inaccuracy of the cash-flow estimates used in the study
2. Type of business involved in relation to the future health of the economy
3. Type of physical plant and equipment involved
4. Length of the study period

Methods of Decision Making under Uncertainty

1. Maximin Criterion: This criterion, also known as the criterion of pessimism, is used when the
decision-maker is pessimistic about future. Maximin implies the maximisation of minimum payoff.
The pessimistic decision-maker locates the minimum payoff for each possible course of action. The
maximum of these minimum payoffs is identified and the corresponding course of action is selected.

Example : Let there be a situation in which a decision-maker has three possible alternatives A1, A2 and A3,
where the outcome of each of them can be affected by the occurrence of any one of the four possible
events S1, S2, S3 and S4. The monetary payoffs of each combination of Ai and Sj are given in the following
table:

Solution: Since 17 is maximum out of the minimum payoffs, the optimal action is A2.

2. Maximax Criterion: This criterion, also known as the criterion of optimism, is used when the
decision-maker is optimistic about future. Maximax implies the maximization of maximum payoff.
The optimistic decision-maker locates the maximum payoff for each possible course of action. The
maximum of these payoffs is identified and the corresponding course of action is selected. The
optimal course of action in the above example, based on this criterion, is A3.

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 3. Regret Criterion: This criterion focuses upon the regret that the decision-maker might have from
selecting a particular course of action. Regret is defined as the difference between the best payoff
we could have realized, had we known which state of nature was going to occur and the realized
payoff. This difference, which measures the magnitude of the loss incurred by not selecting the
best alternative, is also known as opportunity loss or the opportunity cost.

From the payoff matrix (given below), the payoffs corresponding to the actions A1, A2, ...... An under the
state of nature Sj are X1i, X2j, ...... Xnj respectively. Of these assume that X2j is maximum. Then the regret in
selecting Ai, to be denoted by Rij is given by X2j - Xij, i = 1 to m.

We note that the regret in selecting A2 is zero. The regrets for various actions under different states of
nature can also be computed in a similar way.
The regret criterion is based upon the minimax principle, i.e., the decision-maker tries to minimize the
maximum regret. Thus, the decision-maker selects the maximum regret for each of the actions and out of
these the action which corresponds to the minimum regret is regarded as optimal. The regret matrix of
example can be written as given below:

From the maximum regret column, we find that the regret corresponding to the course of action is A3 is
minimum. Hence, A3 is optimal.

4. Hurwicz Criterion: The maximax and the maximin criteria, discussed above, assume that the
decision-maker is either optimistic or pessimistic. A more realistic approach would, however, be to
take into account the degree or index of optimism or pessimism of the decision-maker in the
process of decision-making. If a, a constant lying between 0 and 1, denotes the degree of optimism,
then the degree of pessimism will be 1 - a. Then a weighted average of the maximum and
minimum payoffs of an action, with a and 1 - a as respective weights, is computed. The action with
highest average is regarded as optimal.

We note that a nearer to unity indicates that the decision-maker is optimistic while a value nearer to zero
indicates that he is pessimistic. If a = 0.5, the decision maker is said to be neutralist.
We apply this criterion to the payoff matrix of example 17. Assume that the index of optimism a = 0.7.

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 Since the average for A3 is maximum, it is optimal.

5. Laplace Criterion: In the absence of any knowledge about the probabilities of occurrence of
various states of nature, one possible way out is to assume that all of them are equally likely to
occur. Thus, if there are n states of nature, each can be assigned a probability of occurrence = 1/n.
Using these probabilities, we compute the expected payoff for each course of action and the action
with maximum expected value is regarded as optimal.

Sensitivity Analysis
A sensitivity analysis is a graphical representation to measure the effect of uncertainty in an
economic decision. This can be done by plotting the economic criteria as a function of a parameter. A
flat plot indicates insensitivity.
Sensitivity analysis is used to explore what happens to a project’s profitability when the
estimated value of study factors is changed. For example, if annual expenses turn out to be10% higher
than expected, will the project still be acceptable? Sometimes, sensitivity is specifically defined to mean
the percent change in one or more factors that will reverse a decision among project alternatives or
reverse a decision about the economic acceptability of a single project. This percent change is called
sensitivity with respect to decision reversal. (Sullivan, et. al., 2015)

Tornado chart shows how sensitive the objective is to each decision variable as they change
over their allowed ranges. This chart shows all the decision variables in order of their impact on the
objective.

Example of Tornado Chart

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Methods of Sensitivity Analysis
 Modeling and simulation techniques
 Scenario management tools through Microsoft excel

Approaches in analyzing sensitivity:

1. Local Sensitivity Analysis
 It is derivative based (numerical or analytical) which applicable only for simple cost functions.
 It is a one-at-a-time (OAT) technique that analyzes the impact of one parameter on the cost
function at a time, keeping the other parameters fixed.

2. Global Sensitivity Analysis

 This approach needs set of sample to analyze the sensitivity using Monte Carlo techniques.
Monte Carlo Simulation is a probabilistic method that generates random variables for
modeling risk or uncertainty in a system. These random variables or inputs are modelized on the basis
of probability distributions such as normal, log normal, etc. Different iterations or simulations are run for
generating paths and the outcome is arrived at by using suitable numerical computations.

Advantages of using Sensitivity Analysis

 It aids searching for errors in the model.
 It helps in taking informed and appropriate decisions.
 It helps in assessing the riskiness of the strategy.

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Lesson 10 – Basic Accounting Principles
Topics:
Terminologies in Basic Accounting
Balance Sheet
Income Statement

Learning Outcomes:
At the end of this lesson, the students can use the basic concept of accounting to understand asset and
liabilities of engineering firms.

Accounting Principles

Accounting is the process of recording all the transactions of the company which affect any investment
of capital so that at any given time results of the investment may be known.

Bookkeeping is the systematic recording of all business transactions in financial.

After a decision to invest capital in a project has been made and the capital has been invested, those
who supply and manage the capital want to know the financial results. Financial accounting and cost
accounting are the procedures that provide these necessary services in a business organization.

All accounting is based on the fundamental accounting equation, which is

Assets = liabilities + owner’s equity

Where:
Assets - are things of monetary value that the firm possesses
Liabilities - are those things of monetary value that the firm owes
Owner’s Equity - is the worth of what the firm owes to its stockholders

Balance Sheet
Balance sheet is a financial statement that reports a company’s assets, liabilities and shareholder’s
equity at a specific point in time and provides a basis for computing rates of return and evaluating its capital
structure.

Components of Balance Sheet

 Assets
o Current Assets

 Cash and cash equivalents are the most liquid assets and can include Treasury bills and short-
term certificates of deposit, as well as hard currency.
 Marketable securities are equity and debt securities for which there is a liquid market.
 Accounts receivable refers to money that customers owe the company, perhaps including an
allowance for doubtful accounts since a certain proportion of customers can be expected not to pay.
 Inventory is goods available for sale, valued at the lower of the cost or market price.
 Prepaid expenses represent the value that has already been paid for, such as insurance,
advertising contracts or rent.

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 o Long-term assets

 Fixed assets include land, machinery, equipment, buildings and other durable, generally capital-
intensive assets.
 Intangible assets include non-physical (but still valuable) assets such as intellectual property and
goodwill. In general, intangible assets are only listed on the balance sheet if they are acquired,
rather than developed in-house. Their value may thus be wildly understated – by not including a
globally recognized logo, for example – or just as wildly overstated.

 Liabilities
o Current liabilities

 current portion of long-term debt

 bank indebtedness
 interest payable
 wages payable
 customer prepayments
 dividends payable and others
 earned and unearned premiums
 accounts payable

o Long-term liabilities

 Long-term debt: interest and principal on bonds issued

 Pension fund liability: the money a company is required to pay into its employees' retirement
accounts
 Deferred tax liability: taxes that have been accrued but will not be paid for another year (Besides
timing, this figure reconciles differences between requirements for financial reporting and the way
tax is assessed, such as depreciation calculations.)

***Note: Some liabilities are considered off the balance sheet, meaning that they will not appear on the balance
sheet.

 Shareholders' Equity
o Shareholders' equity is the money attributable to a business' owners, meaning its
shareholders. It is also known as "net assets," since it is equivalent to the total assets of a
company minus its liabilities, that is, the debt it owes to non-shareholders.
o Retained earnings are the net earnings a company either reinvests in the business or use to
pay off debt; the rest is distributed to shareholders in the form of dividends.
o Treasury stock is the stock a company has repurchased. It can be sold at a later date to raise
cash or reserved to repel a hostile takeover.

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Typical Form of Balance Sheet

BALANCE SHEET
Name of Company
Date

ASSETS:
Current Assets
Cash on hand and in banks………………………………………………..
Notes and Accounts Receivable…………………………………………...
Notes receivable customers………………………………………..
Accounts receivable customers……………………………………
Other receivable (give details)……………………………………..
Less: reserve for bad debts…………………………………………
Inventories (goods and materials on hand)………………………………
Total Current Assets…………………………………………………
Fixed Assets
Land
Building or Manufacturing plant ---------------------------
Less Reserve for depreciation ----------------
Properties other than buildings ----------------------------
Less Reserve for depreciation ------------------____________
Total Fixed Assets -------------------------
Prepaid Expenses
These includes amount paid in advance -----------
For insurance, rental, interest, supplies, etc ------- _____________
Total Prepaid Expenses ------------------
Other Assets
Sinking funds -------------------------------------------------------
Investments in securities such as bonds, etc -------
Goodwill -------------------------------------------------------------
Patents, franchises, licenses --------------------------------
Other intangibles --------------------------------------------------
Miscellaneous (give details) ----------------------------------- _____________
Total of Other Assets -----------------------
TOTAL ASSETS --------------- _____________

LIABILITIES:
Current Liabilities
Notes Payable ----------------------------------------------------
Accounts Payables ----------------------------------------------
Accrued Expenses (taxes, wages, interest, etc) ---------
Declared and unpaid dividends ----------------------------------
Other current liabilities (give details) -------------------------- ____________
Total Current Liabilities ----------------------

Fixed Liabilities
Mortgage payable --------------------------------------------------

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 Indebtedness in the form of bonds ----------------------------
Reserve for expansion ---------------------------------------------
Other long term liabilities (give details) ----------------------- ____________
Total Fixed Liabilities --------------------------
Prepaid Income
Advance payment on orders from the company -------
Other income paid in advance to the company -------- __________
Total Prepaid Income --------------------
TOTAL LIABILITIES ----------------------------------------------

OWNERSHIP
Preferred Shares ………………………………………………………..
Common Shares …………………………………………………………
Undivided Surplus ( retained earnings )………………………
TOTAL OWNERSHIP …………………………..
TOTAL : LIABILITIES - OWNERSHIP ………………………………

INCOME STATEMENT
Income statement is a financial statement that shows the profit and loss of a company over a period of
time.
Revenue – Expenses = Profit (or loss)

This relationship defines the format of the income statement (also known as a profit and loss statement), which
summarizes the revenue and expense result of operation over a period of time.

Components of Income statement

 Revenue/Sales
Sales Revenue is the company’s revenue from sales or services, displayed at the very top of the statement.
This value will be the gross of the costs associated with creating the goods sold or in providing services. Some
companies have multiple revenue streams that add to a total revenue line.
 Cost of Goods Sold (COGS)
Cost of Goods Sold (COGS) is a line-item that aggregates the direct costs associated with selling products to
generate revenue. This line item can also be called Cost of Sales if the company is a service business. Direct
costs can include labor, parts, materials, and an allocation of other expenses such as depreciation (see an
explanation of depreciation below).

 Gross Profit
Gross Profit is calculated by subtracting Cost of Goods Sold (or Cost of Sales) from Sales Revenue.

 Marketing, Advertising, and Promotion Expenses

Most businesses have some expenses related to selling goods and/or services. Marketing, advertising, and
promotion expenses are often grouped together as they are similar expenses, all related to selling.

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  General and Administrative (G&A) Expenses
G&A Expenses include the selling, general, and the administrative section that contains all other indirect costs
associated with running the business. This includes salaries and wages, rent and office expenses, insurance,
travel expenses, and sometimes depreciation and amortization, along with other operational expenses. Entities
may, however, elect to separate out depreciation and amortization in its own section.

 Depreciation & Amortization Expense

Depreciation and amortization are non-cash expenses that are created by accountants to spread out the cost
of capital assets such as Property, Plant, and Equipment (PP&E).

 Operating Income (or EBIT)

Operating Income represents what’s earned from regular business operations. In other words, it’s the profit
before any non-operating income, non-operating expenses, interest, or taxes are subtracted from
revenues. EBIT is a term commonly used in finance and stands for Earnings Before Interest and Taxes.

 Interest
Interest Expense is common for companies to split out interest expense and interest income as a separate line
item in the income statement. This is done in order to reconcile the difference between EBIT and EBT. Interest
expense is determined by the debt schedule.

 Other Expenses
Businesses often have other expenses that are unique to their industry. Other expenses may include things
such as fulfillment, technology, research and development (R&D), stock-based
compensation (SBC), impairment charges, gains/losses on the sale of investments, foreign exchange impacts,
and many other expenses that are industry or company-specific.

 EBT (Pre-Tax Income)

EBT stands for Earnings Before Tax, also known as pre-tax income, and is found by subtracting interest
expense from Operating Income. This is the final subtotal before arriving at net income.

 Income Taxes
Income Taxes refer to the relevant taxes charged on pre-tax income. The total tax expense can consist of both
current taxes and future taxes.

 Net Income
Net Income is calculated by deducting income taxes from pre-tax income. This is the amount that flows into
retained earnings on the balance sheet, after deductions for any dividends.

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Example of Form of Income Statement

Income Statement
Company
For the year ending December 31. ____

Income Form Sales

Gross Income -----------------
Less : Return and allowances
Net Sales --------------
Cost of Good Sold
Merchandise inventory at beginning of the year
Purchases and freight
Less : Purchases return and allowances
Cost of Merchandise available for sale
Merchandise inventory at year end
Cost of goods sold
Gross Profit
Operating Expenses:
Selling expenses :
Sale salaries and commissions
Advertising
Other selling expenses (depreciation of sales equipment
Bad debts, delivery expense , insurance on sales
Equipment, etc.)
General and Administrative Expenses:
Office Salaries
Other expenses (rent, telephone, light, taxes, insurance
Depreciation, office supplies, etc)
Total Operating Expenses -------------------------------

Net Operating Profit

Non-Operating income and Expenses
Non-operating income (interest, rent, etc)
Non-operating expenses (interest, sales, discount, etc)
Net Profit -------------------------------------------

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Assessment – Final Grading Quiz 3
Prepare a balance sheet and income statement on the given balances from the books of ABC Motors at
the end of first year operation on December 31, 2014:

Description Debit Credit

Drawings ₱ 12,000
Capital at January 1, 2014 ₱ 52,000
Service motor ₱ 8,000
Property ₱ 40,000
Trade Payables ₱ 3,400
Trade Receivables ₱ 4,100
Cash in hand ₱ 1,300
Cash at bank ₱ 2,200
Insurance ₱ 800
General expenses ₱ 1,200
Heating and lighting ₱ 900
Repairs and maintenance ₱ 1,300
Wages and salaries ₱ 5,100
Purchases ₱ 18,500
Sales ₱ 40,000
Total ₱ 95,400 ₱ 95,400
Inventory at December 31, 2014 was valued at ₱4,500.

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Assessment of course module:
This part of the module is to be answered at the end of the course. It will not evaluate your teacher.
1. What lesson or activity did I enjoy most? Why?
2. What is the most important lesson which I can apply in my daily life?
3. What are the new insights/discoveries that I learned?
4. What topics do I find least important?
5. What possible topics should have been included?

Evaluation of the course:

Question Yes No
1. The syllabus was discussed at the beginning of the course
2. The delivery of the course followed the structure of the syllabus
3. The instructor explained the grading system of the course
4. The activities were related to the course learning outcomes
5. I was able to achieve the learning outcomes of the course

Comment/Suggestion

References:

 Sta. Maria, Hipolito B. (2000). Engineering Economy. Cacho Hermanos, Inc.

 Esplana, Dindo F. (2009). Practice Problems for Civil Engineering Licensure Examination. Calq
Publishing.
 Sullivan, William G, et. al.(2015). Engineering Economy. Pearson. 16th ed.

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