GEN 35 – ENGINEERING

ECONOMY

Northeastern College
College of Geodetic Engineering
ENGR. RONALDO S. SANTIAGO
Instructor
COURSE DESCRPITION
Concepts of the time value of money and equivalence; basic
economy study methods; decisions under certainty; decisions
recognizing risk; and decisions admitting uncertainty.
PROGRAM OUTCOMES
• Ability to identify, formulate, and solve complex geodetic
engineering problems
• Ability to use techniques, skills, and modern engineering tools
necessary for engineering practice
COURSE OUTCOMES
After completing this course, the student must be able to:
1. Solve problems involving interest and the time value of money;
2. Evaluate project alternatives by applying engineering economic
principles and methods and select the most economically efficient
one; and
3. Deal with risk and uncertainty in project outcomes by applying the
basic economic decision making concepts.
QUOTE OF THE DAY

The best way to

predict the Future
is to CREATE IT
 What is
economy?
 is a social system where
people and organization
produce, consume and
exchange goods and
services.
 Then production and
consumption and distribution
of goods and services rely on
the need of the citizens.
Three main types of economy
 FREE MARKET ECONOMIES
 COMMAND ECONOMIES
 MIXED ECONOMIES
FREE MARKET ECONOMIES
- Prices are determined by
supply and demand
COMMAND ECONOMIES
- The government decides
what is produced and may use
non-price formats
MIXED ECONOMIES
- It allows a compromise
between the two extremes of
free markets and central
planning.
What is Economics
 It is the branch of social science that deals with the production,
distribution and consumption of goods and services and their
management.
 It is the study of production and distribution of wealth.
 It is the study of choice and decision-making in the world with
limited resources.
 It is the study of how individuals, business and government use
their limited resources and satisfy unlimited wants.
Engineering and Economics
 Engineering Activities are means of satisfying human wants and
requirements
 Concerns – material, work forces, capital and etc.
 Because of resources constraints, engineering is closely
associated with economics.
 Engineering proposals are evaluated in terms of economics
before it is undertaken.
 Essential pre-requisites of successful engineering application is
economic feasibility
Engineering Economics
 is a collection of mathematical/analytical techniques that
simplify economic comparison.
 formulation, estimation and evaluation of the economic outcomes
out of various available alternatives to accomplish a defined
purposes.
 to be economically acceptable, solutions of engineering problems
must demonstrate a positive balance of long-term benefits over
long term cost.
Engineering Economy
 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.
Seven Principles of Engineering Economy
1) DEVELOP THE ALTENATIVES
2) FOCUS ON THE DIFFERENCES
3) USE A CONSISTENT VIEWPOINT
4) USE COMMON UNIT MEASURE
5) CONSIDER ALL RELEVANT CRITERIA
6) MAKE UNCERTAINLY EXPLICIT
7) REVISIT DECISIONS
DEVELOP THE ALTENATIVES
 The alternatives need to be identified and then defined for
subsequent analysis.
 Since the choice is among alternatives, developing and
defining the comprehensive list of alternatives for detailed
evaluation is important .
 Creativity and innovation are essential.
FOCUS ON THE DIFFERENCES
 Only the difference in expected future outcomes among the
alternatives are relevant to their comparison and should be
considered in the decision.
 Outcomes that are common to all alternatives can be disregarded
in the process of comparison and decision.
USE A CONSISTENT VIEWPOINT
 The prospective outcomes of the alternatives, selection of the
criteria and other, should be consistently developed from a
defined viewpoint.
 Usually, the viewpoint of the decision maker would be used.
USE A COMMON UNIT OF MEASURE
 Using common unit of measurement to enumerate as many of the
prospective outcomes as possible will simplify the analysis of the
alternatives.
 If the outcomes cannot be quantified, describe these
consequences explicitly so that the information is useful to the
decision maker in the comparison of the alternatives.
CONSIDER ALL RELEVANT CRITERIA
MAKE UNCERTAINLY EXPLICIT
 Risk and uncertainty are inherent in estimating the future
outcomes of the alternatives and should be recognized in the
analysis and comparison.
REVISIT YOUR DECISION
 Improved decision making results from an adaptive process
 The initial project outcomes of the selected alternative should be
subsequently compared with the actual results achieved.
 Generally
Engineering Economics is an answer to
following questions.

 Which engineering project are

worthwhile?

 Which engineering projects should have

a higher priority?

 How should the engineering project be

designed?
Consumer and Producer Goods and Services

• Consumer goods and services are

those products or services that are
directly used by people to satisfy
their wants.
• Producers goods and services are
used to produce consumer goods
and services or other producer
goods.
Necessities and Luxuries
 Necessities
• are products or services that are required to support human
and activities that will be purchased in somewhat the same
quantity even though the prices vary considerably.
• (food, everyday clothing, etc., as well as many entertainment
and leisure items like concert tickets)
 Luxuries
• are products and services that are desired by humans and
will be purchased if money is available after the required
necessities have been obtained.
Supply and Demand
 DEMAND
 Is the quantity of a certain commodity that is bought at a
certain price at a given place and time.
3 types of demand
1. Elastic Demand
2. Inelastic Demand
3. Unitary Elasticity of Demand
 Elastic Demand
• Occurs when a decrease in selling price
results in a greater than proportionate
increase in sales.
 Inelastic Demand
• Occurs when a decrease in the selling
price produce a less than proportionate
increase in sale.
 Unitary elasticity of Demand
• Occurs when the mathematical product
of volume and price is constant
LAW OF SUPPLY AND DEMAND
• Under conditions of perfect competition, the price at which a given
product will be supplied and purchased is the price that will result
in the supply and demand being equal.

Generally, as the price increases people are willing to SUPPLY

MORE and DEMAND LESS and vice versa when the price falls.
Market structure
What is market?
- Market is the place where the vendors and buyers meet to
transact.
1. Perfect competition
2. Monopoly
3. Monopsony
4. Duopoly
5. Duopsony
Perfect competition
- Occurs in a situation where a commodity or services is supplied by
a number of vendors and there is nothing to prevent additional
vendors entering the market.
Five conditions for perfect competition:
1. There are many buyers and sellers
2. Standardized products
3. Producers able to enter and exit the market freely
4. Independent buyers and sellers
5. Buyers and sellers are well-informed about their products.
Monopoly
- Is the opposite of perfect competition. A perfect monopoly exist
when a unique product or services is available from a single
vendor and that vendor can prevent the entry of all others into
the market.
Characteristics of a Monopoly
1. Profit maximize
2. Price maker
3. High barriers to entry
4. Single seller
5. Price discrimination
Monopsony
- is a market condition in which there is only one buyer, the
monopsonist.
- In a monopsony, a single buyer generally has a controlling
advantage that drives its consumption price levels down.
- A monopsony can arise due to geographical constraints,
government regulation, or unique consumer demands.
- Monopsonies commonly experience low prices from wholesalers
and an advantage in paid wages.
Duopoly
- is a situation where two companies
together own all, or nearly all, of the
market for a given product or service.
- A duopoly is a form of oligopoly, where
only two companies dominate the market.
- The companies in a duopoly tend to
compete against one another, reducing
the chance of monopolistic market power.
Duosony
- is an economic condition in which there are only two large
buyers for a specific product or service.
- This pair of buyers thus alone determine market demand.
- Their combined bargaining power can lead to less competition and
higher profitability, at the expense of sellers.
Oligopoly
- exist when there are so few suppliers of a product or service
that action by one will almost inevitably result in similar action by
the others.
Oligopsony
- is a market for a product or service which is dominated by a few
large buyers.
- The buyers dominate the market, keeping prices down and
wielding considerable influence over the industry.
Bilateral monopoly
- A bilateral monopoly exists when a market has only one supplier
and one buyer.
- The one supplier will tend to act as a monopoly power and look to
charge high prices to the one buyer.
- The lone buyer will look towards paying a price that is as low as
possible.
Bilateral oligopoly
- is a situation where there is a single (or few) buyer(s) and seller(s)
of a given product in a market.
 Market situation Sellers Buyers
Perfect competition Many Many
Monopoly One Many
Monopsony Many One
Duopoly Two Many
Duopsony Many Two
Oligopoly Few Many
Olygopsony Many Few
Bilateral monopoly One One
Bilateral oligopoly Few Few
Test your knowledge
1. In which of the following market structure is the degree of control
over the price of its product by a firm very large.
a. Imperfect competition
b. Perfect competition
c. Monopoly
d. In A and B both
2. What refers to the exchange mechanism that brings together the
sellers and the buyers of a product, factor of production or
financial security?
Test your knowledge
3. If there are many sellers and few buyers, the market situation is_.

4. What refers to the goods and services that are required to support
human life, need and activities?

5. What market situation exists where there are few sellers and few
buyers?

6. What market situation exist where there is only one buyer and one
seller ?
Test your knowledge
7. What refers to the amount of a product made available for sale?

8. What market situation exist when there are many buyers and
many sellers

9. Duopoly is a market situation where there is/are

Interest
- Is the amount of money paid for the
use of borrowed capital or the income
produced by money which has been
loaned.
Simple interest
- Is calculated using the principal only, ignoring any interest that had
been accrued in preceding periods.
- In practice simple interest is paid on short-term loans in which the time
of the loan is measured in days.
𝑟𝑎𝑡𝑒 𝑜𝑓 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡

𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡
𝑝𝑟𝑖𝑐𝑖𝑝𝑎𝑙 𝑛𝑜. 𝑜𝑓 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑝𝑒𝑟𝑖𝑜𝑑

𝑓𝑢𝑡𝑢𝑟𝑒 𝑤𝑜𝑟𝑡ℎ
Simple interest
 Ordinary simple interest
 The interest is computed on the basis of one bankers year.
1 bankers year = 12 months
30 days each month = 360 days
1 interest period = 360 days
 Exact simple interest
 Based on the exact number of days in a year.
 365 days for an ordinary year
 366 days for a leap year
Simple interest
Leap year occurs every four years that is exactly divisible by four, except
century marks (1800,1900, etc.) But not including those that are exactly
divisible by 400 (2000, 2400, etc.).
Sample Problems
1. Determine the ordinary simple interest on P700 for 8 months and 15 days if the rate
of interest is 15%.
2. What will be the future worth of money after 14 months, if a sum of P10,000 is
invested today at a simple interest rate of 12% per year?
3. If a man borrowed money from his girlfriend with simple interest rate of 12%,
determine the present worth of P74,900.00, which due at the end of seven months.
4. Clara has invested P10,000.00, part at 5% and the remainder at 10% simple
interest. How much is invested at higher rate if the total annual interest from this
investment is P950?
5. Determine the accumulated amount using exact simple interest on P10,000 for the
period from January 20, 1990 to November 28 of the same year at 15% interest
rate.
6. Determine the exact simple interest on P500 for the period from January 10 to
October 28 1996 at 16% interest.
𝑷𝑹𝑶𝑪𝑬𝑬𝑫 𝑻𝑶 𝑨𝑺𝑺𝑰𝑮𝑵𝑴𝑬𝑵𝑻
1. Determine the ordinary simple interest 2. What will be the future worth of money after 14
on P700 for 8 months and 15 days if months, if a sum of P10,000 is invested today at a
the rate of interest is 15%. simple interest rate of 12% per year?

𝑃 = 700 𝑃 = 10,000

𝑛𝑜. 𝑜𝑓 𝑑𝑎𝑦𝑠 = 8 30 + 15 = 255𝑑𝑎𝑦𝑠 𝑛𝑜. 𝑜𝑓 𝑑𝑎𝑦𝑠 = 14 𝑚𝑜𝑛𝑡ℎ𝑠

𝑖 = 15% 𝑖 = 12%

𝐼 =? 𝐹 =?

𝐼 = 𝑃𝑛𝑖 𝐹 = 𝑃(1 + 𝑛𝑖)

255
𝐼 = 700( )(0.15) 14
360 𝐹 = 10000(1 + 0.12 )
12

𝑰 = 𝑷𝟕𝟒. 𝟑𝟖
𝑭 = 𝑷𝟏𝟏𝟒𝟎𝟎
3. If a man borrowed money from his 4. Clara has invested P10,000.00, part at 5% and the
girlfriend with simple interest rate of remainder at 10% simple interest. How much is
12%, determine the present worth of invested at higher rate if the total annual interest from
P74,900.00, which due at the end of this investment is P950?
seven months.

𝑖 = 12% 𝑃5 = 𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 @ 𝑎 𝑟𝑎𝑡𝑒 𝑜𝑓 5%

𝑃 =? 𝑃10 = 𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 @ 𝑎 𝑟𝑎𝑡𝑒 𝑜𝑓 10%

𝐹 = 74900 𝐼 = 950

𝑛𝑜. 𝑑𝑎𝑦𝑠 = 7 𝑚𝑜𝑛𝑡ℎ𝑠 𝑃5 + 𝑃10 = 10000 𝑒𝑞. 1

𝐹 = 𝑃(1 + 𝑛𝑖) 𝐼 = 𝑃𝑛𝑖

𝐹 𝑃 1 0.05 + 𝑃 1 0.10 = 950 𝑒𝑞. 2

𝑃=
1 + 𝑛𝑖
𝑡𝑤𝑜 𝑒𝑞𝑢𝑎𝑡𝑖𝑜𝑛 𝑡𝑤𝑜 𝑢𝑛𝑘𝑛𝑜𝑤𝑛
74900
𝑃=
7
1 + ((12)(0.12)) 𝑃 = 1,000 𝑷𝟏𝟎 = 𝟗, 𝟎𝟎𝟎

𝑷 = 𝑷𝟕𝟎, 𝟎𝟎𝟎
5. Determine the accumulated amount using exact simple interest on P10,000 for the period from January
20, 1990 to November 28 of the same year at 15% interest rate.

Jan 31
𝐹 =?
Feb 28
𝑃 = 10000
Mar 31
𝑖 = 15%
April 30
𝑛= May 31
June 30
July 31
Aug 31
Sept 30
Oct 31
Nov 30
Dec 31
5. Determine the accumulated amount using exact simple interest on P10,000 for the period from January
20, 1990 to November 28 of the same year at 15% interest rate.

Jan 31-20 = 11
𝐹 =?
Feb 28
𝑃 = 10000 𝐹 = 𝑃(1 + 𝑛𝑖)
Mar 31
𝑖 = 15% 312
April 30 𝐹 = 10000(1 + 0.15 )
𝑛= 31 365
May
June 30 𝑭 = 𝑷𝟏𝟏, 𝟐𝟖𝟐. 𝟏𝟗
July 31
Aug 31
Sept 30
Oct 31
Nov 28
312 𝑑𝑎𝑦𝑠

BACK TO PAGE 46
6. Determine the exact simple interest on P500 for the period from January 10 to October 28 1996 at 16%
interest.

Jan 31-10 = 21 𝑦𝑒𝑎𝑟 1996 𝑖𝑠 𝑎 𝑙𝑒𝑎𝑝 𝑦𝑒𝑎𝑟

Feb 29
Mar 31 𝐼 = 𝑃𝑛𝑖
April 30
May 292
31 𝐼 = 500( )(0.16)
366
June 30
July 31
𝑰 = 𝑷𝟔𝟑. 𝟖𝟑
Aug 31
Sept 30
Oct 28
292 𝑑𝑎𝑦𝑠
ASSIGNMENT
1. An investment with simple interest rate “i", yields an annual
interest of P 1,250. If P 250 more is invested and the rate is 3%
less, the annual interest is P 1,000. Determine the rate of simple
interest “i”?
2. If P5,000 becomes P7,925 after 3 years and 3 months, what is the
simple interest rate?
3. A man borrows P10,000 from a loan firm. The rate of simple
interest is 15%, but the interest is to be deducted from the loan at
the time the money is borrowed. At the end of one year he has to
pay back P10,000. What is the actual rate of interest?

𝑷𝑹𝑶𝑪𝑬𝑬𝑫 𝑻𝑶 𝑬𝑿𝑨𝑴𝑷𝑳𝑬 # 𝟏
1. An investment with simple interest rate 𝒏𝒆𝒙𝒕
“i", yields an annual interest of P 1,250. If
P 250 more is invested and the rate is
3% less, the annual interest is P 1,000.
Determine the rate of simple interest “i”?

𝑃 1 𝑖 = 1250

1250
𝑃= 𝑒𝑞. 1
𝑖

𝑃 + 250 1 𝑖 − 0.03 = 1000 𝑒𝑞. 2

1250 + 250𝑖
𝑖 − 0.03 = 1000
𝑠𝑢𝑏𝑠𝑡𝑖𝑡𝑢𝑡𝑒 𝑒𝑞. 1 𝑖𝑛𝑡𝑜 𝑒𝑞𝑢𝑎𝑡𝑖𝑜𝑛2 𝑖

1250 250𝑖 + 1250𝑖 − 7.5𝑖 − 37.50

+ 250 1 𝑖 − 0.03 = 1000 = 1000
𝑖 𝑖

250𝑖 + 242.50𝑖 − 37.5 = 0

𝒊 = 𝟏𝟑. 𝟓𝟕%
𝑖 = 0.1357
𝒖𝒔𝒆 𝒕𝒉𝒆 𝒑𝒐𝒔𝒔𝒊𝒕𝒊𝒗𝒆 𝒗𝒂𝒍𝒖𝒆
𝑖 = −1.1057 𝐚𝐬 𝐚𝐧𝐬𝐰𝐞𝐫
2. If P5,000 becomes P7,925 after 3 years and 3 months, what is the simple interest rate?

𝐹 = 𝑃(1 + 𝑛𝑖) 𝐹 −𝑃
𝑖=
𝑃𝑛
𝑃 = 5000
7925 − 5000
𝑖=
𝐹 = 7925 39
5000(12)

𝑛𝑜. 𝑜𝑓 𝑚𝑜𝑛𝑡ℎ𝑠 = 3 12 + 3 = 39 𝑚𝑜𝑛𝑡ℎ𝑠

𝒊 = 𝟏𝟖%
𝑖 =?
3. A man borrows P10,000 from a loan firm. The rate of simple interest is 15%, but the interest is to be
deducted from the loan at the time the money is borrowed. At the end of one year he has to pay
back P10,000. What is the actual rate of interest?

𝐼 = 𝑃𝑛𝑖 𝑃 = 10000(1 − 0.15)

𝐼 = 10000 (1)(0.15)
𝑃 = 8500
𝐼 = 𝑃1500
𝐹 = 𝑃(1 + 𝑛𝑖)
10,000
1500
8,500 𝑁𝑒𝑤 𝑝𝑟𝑖𝑛𝑐𝑖𝑝𝑎𝑙 10000 = 8500(1 + (1)𝑖)

𝐹 = 𝑃(1 + 𝑛𝑖) 𝒊 = 𝟏𝟕. 𝟔𝟓%

10000 = 8500(1 + (1)𝑖)

𝒊 = 𝟏𝟕. 𝟔𝟓%
 Discount
 Is the difference between the present worth and the worth of paper at
some time in the future.

Discount = Future worth – Present worth

𝟏
𝒅=𝟏− 𝟏+𝒊

𝒅
𝒊=
𝟏−𝒅

𝑑 = 𝑟𝑎𝑡𝑒 𝑜𝑓 𝑑𝑖𝑠𝑐𝑜𝑢𝑛𝑡 𝑓𝑜 𝑡ℎ𝑒 𝑝𝑒𝑟𝑖𝑜𝑑 𝑖𝑛𝑣𝑜𝑙𝑣𝑒𝑑

𝑖 = 𝑟𝑎𝑡𝑒 𝑜𝑓 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑓𝑜 𝑡ℎ𝑒 𝑠𝑎𝑚𝑒 𝑝𝑒𝑟𝑖𝑜𝑑

Compound interest
 In calculation of compound interest, the interest for an interest period
is calculated on the principal plus total amount of interest accumulated
in previous period.
 INTEREST ON TOP IF INTEREST 𝑙𝑒𝑡:
𝐹 = 𝑎𝑐𝑐𝑢𝑚𝑢𝑙𝑎𝑡𝑒𝑑 𝑎𝑚𝑜𝑢𝑛𝑡 𝑜𝑟 𝑓𝑢𝑡𝑟𝑒 𝑤𝑜𝑟𝑡ℎ
o 1 2 3 4 5 n
𝑃 = 𝑝𝑟𝑖𝑛𝑐𝑖𝑝𝑎𝑙 𝑜𝑟 𝑝𝑟𝑒𝑠𝑒𝑛𝑡 𝑤𝑜𝑟𝑡ℎ
𝑟 = 𝑛𝑜𝑚𝑖𝑛𝑎𝑙 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑟𝑎𝑡𝑒
P 𝐹
𝐹 𝑖 = 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡𝑟 𝑟𝑎𝑡𝑒 𝑝𝑒𝑟 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑝𝑒𝑟𝑖𝑜𝑑
𝐹
𝐹 𝑚 = 𝑛𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑖𝑛𝑡𝑒𝑟𝑠𝑡 𝑝𝑒𝑟𝑖𝑜𝑑 𝑝𝑒𝑟 𝑦𝑒𝑎𝑟
𝐹
𝐹 𝑛 = 𝑡𝑜𝑡𝑎𝑙 𝑛𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑝𝑒𝑟𝑖𝑜𝑑𝑠
𝑡 = 𝑛𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑦𝑒𝑎𝑟𝑠 𝑜𝑓 𝑖𝑛𝑣𝑒𝑠𝑡 𝑚𝑒𝑛𝑡
 Compound interest
𝑙𝑒𝑡:
o 1 2 3 4 5 n
𝐹 = 𝑎𝑐𝑐𝑢𝑚𝑢𝑙𝑎𝑡𝑒𝑑 𝑎𝑚𝑜𝑢𝑛𝑡 𝑜𝑟 𝑓𝑢𝑡𝑟𝑒 𝑤𝑜𝑟𝑡ℎ
𝑃 = 𝑝𝑟𝑖𝑛𝑐𝑖𝑝𝑎𝑙 𝑜𝑟 𝑝𝑟𝑒𝑠𝑒𝑛𝑡 𝑤𝑜𝑟𝑡ℎ
P
𝐹 𝑟 = 𝑛𝑜𝑚𝑖𝑛𝑎𝑙 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑟𝑎𝑡𝑒
𝐹
𝐹
𝐹 𝑖 = 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡𝑟 𝑟𝑎𝑡𝑒 𝑝𝑒𝑟 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑝𝑒𝑟𝑖𝑜𝑑
𝐹
𝐹 = 𝑃(1 + 𝑖) 𝐹
𝑚 = 𝑛𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑖𝑛𝑡𝑒𝑟𝑠𝑡 𝑝𝑒𝑟𝑖𝑜𝑑 𝑝𝑒𝑟 𝑦𝑒𝑎𝑟
𝐹 = 𝑃(1 + 𝑖) (1 + 𝑖) = 𝑃 1 + 𝑖 𝑛 = 𝑡𝑜𝑡𝑎𝑙 𝑛𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑝𝑒𝑟𝑖𝑜𝑑𝑠

𝐹 = 𝑃 1 + 𝑖 (1 + 𝑖) = 𝑃 1 + 𝑖 𝑡 = 𝑛𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑦𝑒𝑎𝑟𝑠 𝑜𝑓 𝑖𝑛𝑣𝑒𝑠𝑡 𝑚𝑒𝑛𝑡

𝐹 = 𝑃 1 + 𝑖 (1 + 𝑖) = 𝑃 1 + 𝑖 𝒏
𝑭𝒏 = 𝑷 𝟏 + 𝒊

𝐹 = 𝑃 1 + 𝑖 (1 + 𝑖) = 𝑃 1 + 𝑖 𝑭𝒏
𝑷= 𝒏
𝟏+𝒊
 Compound interest
𝑙𝑒𝑡:
o 1 2 3 4 5 n
𝐹 = 𝑎𝑐𝑐𝑢𝑚𝑢𝑙𝑎𝑡𝑒𝑑 𝑎𝑚𝑜𝑢𝑛𝑡 𝑜𝑟 𝑓𝑢𝑡𝑟𝑒 𝑤𝑜𝑟𝑡ℎ
𝑃 = 𝑝𝑟𝑖𝑛𝑐𝑖𝑝𝑎𝑙 𝑜𝑟 𝑝𝑟𝑒𝑠𝑒𝑛𝑡 𝑤𝑜𝑟𝑡ℎ
P
𝐹 𝑟 = 𝑛𝑜𝑚𝑖𝑛𝑎𝑙 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑟𝑎𝑡𝑒
𝐹
𝐹
𝐹 𝑖 = 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡𝑟 𝑟𝑎𝑡𝑒 𝑝𝑒𝑟 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑝𝑒𝑟𝑖𝑜𝑑
𝐹
𝐹
𝑚 = 𝑛𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑖𝑛𝑡𝑒𝑟𝑠𝑡 𝑝𝑒𝑟𝑖𝑜𝑑 𝑝𝑒𝑟 𝑦𝑒𝑎𝑟
6% 𝑐𝑜𝑚𝑝𝑜𝑢𝑛𝑑𝑒𝑑 𝑚𝑜𝑛𝑡ℎ𝑙𝑦 𝑓𝑜𝑟 10 𝑦𝑒𝑎𝑟𝑠
𝑛 = 𝑡𝑜𝑡𝑎𝑙 𝑛𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑝𝑒𝑟𝑖𝑜𝑑𝑠
𝑡 = 𝑛𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑦𝑒𝑎𝑟𝑠 𝑜𝑓 𝑖𝑛𝑣𝑒𝑠𝑡 𝑚𝑒𝑛𝑡
𝑚 = 12 𝑛𝑢𝑚𝑏𝑒𝑟 𝑜𝑓
𝑛𝑜𝑚𝑖𝑛𝑎𝑙 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡
𝑦𝑒𝑎𝑟𝑠, 𝑡 𝒓
𝑟𝑎𝑡𝑒 (𝑟) 𝒊= 𝒏 = 𝒎𝒕
𝒎
0.06
𝑖= 𝑛 = 12(10)
12
 Compound interest
o 1 2 3 4 5 n 𝑐𝑜𝑚𝑝𝑜𝑢𝑛𝑑𝑒𝑑 𝑎𝑛𝑛𝑢𝑎𝑙𝑙𝑦 =1
𝑐𝑜𝑚𝑝𝑜𝑢𝑛𝑑𝑒𝑑 𝑠𝑒𝑚𝑖 − 𝑎𝑛𝑛𝑢𝑎𝑙𝑙𝑦 =2
𝑐𝑜𝑚𝑝𝑜𝑢𝑛𝑑𝑒𝑑 𝑞𝑢𝑎𝑟𝑡𝑒𝑟𝑙𝑦 =4
P
𝐹
𝐹 𝑐𝑜𝑚𝑝𝑜𝑢𝑛𝑑𝑒𝑑 𝑏𝑖 − 𝑚𝑜𝑛𝑡ℎ𝑙𝑦 =6
𝐹
𝐹
𝐹 𝑐𝑜𝑚𝑝𝑜𝑢𝑛𝑑𝑒𝑑 𝑚𝑜𝑛𝑡ℎ𝑙𝑦 = 12
𝐹
6% 𝑐𝑜𝑚𝑝𝑜𝑢𝑛𝑑𝑒𝑑 𝑚𝑜𝑛𝑡ℎ𝑙𝑦 𝑓𝑜𝑟 10 𝑦𝑒𝑎𝑟𝑠 𝒓
𝒊= 𝒏 = 𝒎𝒕
𝒎

𝑚 = 12 𝑛𝑢𝑚𝑏𝑒𝑟 𝑜𝑓
𝑛𝑜𝑚𝑖𝑛𝑎𝑙 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡
𝑦𝑒𝑎𝑟𝑠, 𝑡 𝑭𝒏 = 𝑷 𝟏 + 𝒊 𝒏
𝑟𝑎𝑡𝑒 (𝑟)

0.06 𝒓 𝒎𝒕
𝑖= 𝑛 = 12(10) 𝑭𝒏 = 𝑷 𝟏 +
12 𝒎
Compound interest
Continuous compounding
it is assumed that cash payments occur once per year, but the compounding
is continuous throughout the year.

𝒓𝒕

EFFECTIVE RATE OF INTEREST

is the actual or exact interest rate of interest on the principal during one year.

𝐸𝑓𝑓𝑒𝑐𝑡𝑖𝑣𝑒 𝑟𝑎𝑡𝑒 (𝐸𝑅)

𝒊𝒏𝒕𝒆𝒓𝒆𝒔𝒕 𝒆𝒂𝒓𝒏𝒆𝒅 𝒊𝒏 𝒐𝒏𝒆 𝒚𝒆𝒂𝒓 𝑬𝒇𝒇𝒆𝒄𝒕𝒊𝒗𝒆 𝒓𝒂𝒕𝒆 𝒄𝒐𝒏𝒕𝒊𝒏𝒖𝒐𝒖𝒔 𝒄𝒐𝒎𝒑𝒐𝒖𝒏𝒅𝒊𝒏𝒈
𝑬𝑹 =
𝒑𝒓𝒊𝒏𝒄𝒊𝒑𝒂𝒍 𝒂𝒕 𝒕𝒉𝒆 𝒃𝒆𝒈𝒊𝒏𝒏𝒊𝒏𝒈 𝒐𝒇 𝒕𝒉𝒆 𝒚𝒆𝒂𝒓 𝒓

𝒓 𝒎
𝑬𝑹 = 𝟏 + −𝟏
𝒎
Sample Problem
1. A man borrowed P5,000 from a bank and agreed to pay the loan at the period
of 9 months. The bank discounted the loan and gave him P4,000 in cash. (a.)
what was the rate of discount? (b.) what was the rate of interest? (c.) what
was the rate of interest for one year?
2. An interest of 8% compounded semi-annually is how many percent if
compounded quarterly?
3. A man has a will of P650,000 from his father. If his father deposited an
amount of P450,000 in a trust fund earning 8% compounded annually, after
how many years will the man receive his will?
4. The nominal interest rate is 4%. How much is my P10,000 worth in 10 years
in a continuously compounded account?
5. Compute the effective rate for an interest rate of 16% compounded quarterly?
6. What amount will be accumulated by a present investment of P17200 in 6
years at 2% compounded quarterly?
1. A man borrowed P5,000 from a bank and agreed to
pay the loan at the period of 9 months. The bank
discounted the loan and gave him P4,000 in cash. (a.)
what was the rate of discount? (b.) what was the rate
of interest? (c.) what was the rate of interest for one
year?

0.20
𝐷 = 5000 − 4000 𝑖 = 𝐼 = 𝑃𝑛𝑖
1 − 0.20
𝐷 = 1,000
9
1000 = 4000( )(𝑖)
1000 𝑖 = 0.25 𝑜𝑟 25% 12
𝑑=
5000
𝑖 = 33.33%
𝑑 = 0.2 𝑜𝑟 20 %
2. An interest of 8% compounded semi-annually is how
many percent if compounded quarterly?

𝑟 𝑟
1+ −1 = 1+ −1
𝑚 𝑚

0.08 𝑟
1+ −1 = 1+ −1
2 4

𝑟 = 7.92%
3. A man has a will of P650,000 from his father. If his
father deposited an amount of P450,000 in a trust fund
earning 8% compounded annually, after how many
years will the man receive his will?

𝑟
𝐹 =𝑃 1+
𝑚

( )
0.08
650000 = 450000 1 +
1

𝑡 = 4.77 𝑦𝑒𝑎𝑟𝑠
4. The nominal interest rate is 4%. How much is my
P10,000 worth in 10 years in a continuously
compounded account?

𝐹 = 𝑃𝑒

𝐹 = 10000𝑒 .

𝐹 = 𝑃14918.25
5. Compute the effective rate for an 6. What amount will be accumulated by a present
interest rate of 16% compounded investment of P17200 in 6 years at 2% compounded
quarterly? quarterly?

𝐹=
𝑟
𝐸𝑅 = 1 + −1
𝑚 2%
𝑃 = 17,200 𝐹 = 17200 1 +
4
0.16 𝑡 = 6𝑦𝑒𝑎𝑟𝑠
𝐸𝑅 = 1+ −1
4 𝑟 = 2%
𝐹 = 𝑃19387.15
𝑚=4
𝐸𝑅 = 16.99%
𝑛 = 𝑚𝑡 = 4 6 = 24

𝑟
𝐹 =𝑃 1+
𝑚

𝑏𝑎𝑐𝑘 𝑡𝑜 𝑝𝑎𝑔𝑒 62
1. What payment X ten years from now is equivalent to a payment of P1,000 six years
from now, if interest is 15% compounded monthly.
2. An investment of P3M earns interest of 9% compounded continuously. What is the
effective rate of interest?
3. What rate in percent compounded monthly is equivalent to 18% compounded semi-
annually?
4. When compounded bi-monthly, P150,000 becomes P223,183 after 5 years. What is the
nominal rate of interest?
5. A firm borrows P2,000 for 6 years at 8%. At the end of 6 years, it renews the loan for the
amount due plus P2,000 more for 2 years at 8%. What is the lump sum due?
6. It is the practice of almost all bank in the Philippines that when they grant a loan, the
interest for one year is automatically deducted from the principal amount upon release of
money to a borrower. Let us therefore assume that you applied for a loan with bank and
the P80,000 was approved at an interest rate of 14% of which P11,200 was deducted and
you were given a check of P68,800. Since you have to pay the amount of P80,000 one year
after, what then will be the effective interest rate?
1. What payment X ten years from now is
equivalent to a payment of P1,000 six years from
now, if interest is 15% compounded monthly.
4 𝑦𝑒𝑎𝑟𝑠
0 1 2 3 4 5 6 7 8 9 10

𝑃 1000
𝑥

𝑟
𝐹 = 𝑃 1+
𝑚
𝐹 = 𝑃1815.35
( )
15%
𝐹 = 1000 1 +
12
2. An investment of P3M earns interest of 9% compounded continuously. What is the effective
rate of interest?

𝐸𝑅 = 𝑒 − 1 𝐸𝑅 = 𝑒 % −1 𝐸𝑅 = 9.42%

3. What rate in percent compounded monthly is equivalent to 18% compounded semi-annually?

𝑟 𝑟
1+ −1= 1+ −1
𝑚 𝑚

𝑟 = 17.36%
𝑟 18%
1+ −1= 1+ −1
12 2
 4. When compounded bi-monthly, P150,000 becomes P223,183 after 5 years. What is the
nominal rate of interest?

𝑟
𝑃 = 150,000 𝐹 = 223,183 𝑡 = 5𝑦𝑒𝑎𝑟𝑠 𝑟= 𝑚=6 𝐹 =𝑃 1+
𝑚

𝑟 ( )
223,183 = 150,000 1 + 𝑟 = 8%
6

5. A firm borrows P2,000 for 6 years at 8%. At the end of 6 years, it renews the loan for the
amount due plus P2,000 more for 2 years at 8%. What is the lump sum due?

𝑃 = 2,000
𝐹 = 𝐹6 + 2000 1 + 𝑖
𝑡 = 6 𝑦𝑒𝑎𝑟𝑠
𝐹 = 3,173.75 𝐹 = 3173.75 + 2000 1 + 8%
𝑖 = 8%

𝐹 =𝑃 1+𝑖
𝐹 = 6,034.66
𝐹 = 2,000 1 + 8%
6. It is the practice of almost all bank in the Philippines that when they grant a loan, the
interest for one year is automatically deducted from the principal amount upon release of
money to a borrower. Let us therefore assume that you applied for a loan with bank and
the P80,000 was approved at an interest rate of 14% of which P11,200 was deducted and
you were given a check of P68,800. Since you have to pay the amount of P80,000 one year
after, what then will be the effective interest rate?

𝑑 = 14% 𝐹 = 𝑃(1 + 𝑖) 11,200

𝑖=
68,800
𝑑 80,000 = 68,800(1 + 𝑖)
𝑖=
1−𝑑
14% 𝑖 = 16.28% 𝑖 = 16.28%
𝑖=
1 − 14%

𝑖 = 16.28%