Economics Reviewer

Reviewer/Interest Formulas
21. (Part I) A uniform payment series is one that

consists of equal payments
a) starting now up to year n
b) starting one year from now up to year n
c) starting one year from now increasing by a
uniform amount up to year n
d) none of the above
Answer: b
1 2 3 4 5 6 7 n-1 n
P
Table of interest factors for discrete compounding; interest rate of 5%
n (F/P,I%,n) (P/F,I%,n) (F/A,I%,n) (A/F,I%,n) (P/A,I%,n) (A/P,I%,n) (A/G,I%,n)
1 1.0500 0.9524 1.0000 1.0000 0.9524 1.0500 0.0000
2 1.1025 0.9070 2.0500 0.4878 1.8594 0.5378 0.4878
3 1.1576 0.8638 3.1525 0.3172 2.7232 0.3672 0.9675
4 1.2155 0.8227 4.3101 0.2320 3.5460 0.2820 1.4391
5 1.2763 0.7835 5.5256 0.1810 4.3295 0.2310 1.9025
6 1.3401 0.7462 6.8019 0.1470 5.0757 0.1970 2.3579
7 1.4071 0.7107 8.1420 0.1228 5.7664 0.1728 2.8052
8 1.4775 0.6768 9.5491 0.1047 6.4632 0.1547 3.2445
9 1.5513 0.6446 11.0266 0.0907 7.1078 0.1407 3.6758
10 1.6289 0.6139 12.5779 0.0795 7.7217 0.1295 4.0991
11 1.7103 0.5847 14.2068 0.0704 8.3064 0.1204 4.5144
12 1.7959 0.5568 15.9171 0.0628 8.8633 0.1128 4.9219
13 1.8856 0.5303 17.7130 0.0565 9.3936 0.1065 5.3215
14 1.9799 0.5051 19.5986 0.0510 9.8986 0.1010 5.7133
15 2.0789 0.4810 21.5786 0.0463 10.3797 0.0963 6.0973
16 2.1829 0.4581 23.6575 0.0423 10.9378 0.0923 6.4736
17 2.2920 0.4363 25.8404 0.0367 11.2741 0.0887 6.8423
18 2.4066 0.4155 28.1324 0.0355 11.6896 0.0855 7.2034
19 2.5270 0.3957 30.5390 0.0327 12.0853 0.0827 7.5569
20 2.6533 0.3769 33.0660 0.0302 12.4622 0.0802 7.9030
21 2.7860 0.3589 35.7193 0.0280 12.8212 0.0780 8.2416
22 2.9253 0.3418 38.5052 0.0260 13.1630 0.0760 8.5730
23 3.0715 0.3256 41.4305 0.0241 13.4886 0.0741 8.8971
24 3.2251 0.3101 44.5020 0.0225 13.7986 0.0725 9.2140
25 3.3864 0.2953 47.7271 0.0210 14.0939 0.0710 9.5238
30 4.3219 0.2314 66.4388 0.0151 15.3725 0.0651 10.9691
35 5.5160 0.1813 90.3203 0.0111 16.3742 0.0611 12.2498
40 7.0400 0.1420 120.7998 0.0083 17.1591 0.0583 13.3775
50 11.4674 0.0872 209.3480 0.0048 18.2559 0.0548 15.2233
60 18.6792 0.0535 353.5837 0.0028 18.9293 0.0528 16.6062
80 49.5614 0.0202 971.2290 0.0010 19.5965 0.0510 18.3526
100 131.5010 0.0076 2610.025 0.0004 19.8479 0.0504 19.2337
22. (Part I) The equal payment series sinking fund factor
is used
a) to find F given A c) to find A given F

b) to find A given P d) none of the above
Answer: c
F
A
0 1 2 3 4 5 6 7 n
23. (Part I) The amount of P65,000 was to be borrowed at
an annual interest rate of 12% to be repaid in 5 years. Two
different plans, both equally desirable, could be selected to
repay the loan. The first plan requires paying 1/5 of the
principal each year + interest due. The second plan
requires paying an equal amount every year. In Plan 1, the
amount to be repaid at the end of year 1 will be closest to
a) P17,680 b) P20,800 c) P18,240 d) P16,120
Given: P = P65,000
i=12%/yr
n = 5 yrs
For Plan 1, 1st payment = I + 1/5P
Find: Amt of 1st payment
Solution:
1st Payment = I + 1/5P = (P×i) + 1/5P
= (65,000×0.12) + (1/5)(65,000)
= 7,800 + 13,000 = P20,800 b
The meaning of economic equivalence
 Economic equivalence – means that different sums of money at
different times can be equal in economic value. It is established,
in general, when we are indifferent between a future payment, or
a series of future payments, and a present sum of money.
 Some principles of equivalence:
- Equivalent cash flows have the same economic value at the
same point in time.
- Cash flows that are equivalent at one point in time are
equivalent at any other point in time.
- If cash flow A is equivalent to cash flow B, and cash flow B is
equivalent to cash flow C, then A must be equivalent to C.
-The actual interest rate received or paid is the interest that sets
the equivalent receipts equal to the equivalent disbursements.
24. (Part I) A loan can be repaid in 4 years using any of the 3 following plans:
Plan End-of Interest Total owed at Payment

end of Year
Year for Year
Plan 1 1 7,200 97,200 27,173
2 5,602 75,629 27,173
3 3,876 52,332 27,173
4 2,013 27,173 27,173
Plan 2 1 7,200 97,200 0
2 7,776 104,976 0
3 8,398 113,374 0
4 9,070 122,444 122,444
Plan 3 1 7,200 97,200 7,200
2 7,200 97,200 7,200
3 7,200 97,200 7,200
4 7,200 97,200 97,200
The original amount of the loan is:
a) P72,000 c) P108,692
b) P90,000.00 d) P97,200
Given: 3 different plans to pay a loan as shown in the table.

Find: P
Solution: Since interest rate is not given, it is best to look at
interest earned and total amount owed at the end of year 1.
For all plans, total amount owed at year 1, F1 = P97,200.
Interest earned for year 1, I1 = P7,200.
Therefore, P = F1 – I1 = P97,200 – P7,200 = P90,000 b
25. (Part I) The value of the interest factor needed to find
the equivalent at time 0 of P155,000 occurring 7 years
from now when interest rate is 9% per year compounded
yearly is
a) 1.8280 c) 0.0129
b) 0.5470 d) none of the above
Given: F7 = P155,000
n = 7 yrs
i = 9%/yr
Find: Value of interest facto to find P given F
Solution:
Cash flow diagram is as follows:
F = P155,000
(P/F)
i=9%/yr n=7yrs
P?
(P/F,i,n) = (1+i)-n = (1 + 0.09)-7 = 0.5470 b
26. (Part I) The value of the interest factor needed to
find a series of equal revenues that must be received
every year for 12 years to realize a return of 25% from
an initial investment of P25M is
a) 0.2685 c) 0.0687
b) 0.0185 d) none of the
above
1 2 3 4 5 6 7 8 9 10 11 12
P = P25M (A/P,i,n) = [i×(1+i)n] = [0.25×(1+0.25)12]

(1+i)n-1 (1+0.25)12-1
(A/P,i,n) = 0.2684 a
Reviewer/Interest Formulas (Part II)
1. Five years ago, P12,000 was deposited into a savings
account that provides an interest of 6.5% compounded
annually. If a uniform amount of P3,000 was withdrawn
yearly starting at the end of the first year after the initial
deposit was made, then
a) all the money will be gone by now
b) an amount greater than P3,000 can still be
withdrawn now
c) an amount less than P3,000 can still be withdrawn
now
A= P3,000
A5=P3,000?
1 2 3 4 5
i=6.5%/yr
P=P12,000
Solution 1: Step-wise approach
End of P I P+I Amt Remaining

year withdrawn amount after
year n
1 12,000 780 12,780 3,000 9,780
2 9,780 635.7 10,416 3,000 7,416
3 7,416 482 7,898 3,000 4,898
4 4,898 318 5,216 3,000 2,216
5 2,216 144 2,360 3,000? -640
Answer: c
Solution 2: Analytical approach
A  P  ( A / P, i, n)
[i  (1  i ) n ]
A  P
(1  i ) n  1
[0.065  (1  0.065)5 ]
A  12,000 
(1  0.065)5  1
A  P 2,888 Uniform amt to be withdrawn to last 5 years
Since the amount withdrawn for the last 4 years exceeds
the amount of P2,888, then it follows that the amount that
can be withdrawn on the 5th year can not be P3,000.
2. A loan of P10,000 is to be paid in 3 years at an
interest of 6% per year. Which of the payment plans
below is not equivalent to the others?
a) Pay interest payment of P600 each year during the
first 2 years and P10,600 at the end of the third year.
b) Pay P4,600 at the end of the first year, P3,600 at
the end of the second year and P3,600 at the end of the
3rd year.
c) Pay with a single amount of P11,910 at the end of
3 years.
d) Pay with 3 equal payments of P3,741 every year for
3 years.
Given: P = P10,000
n = 3 yrs
i = 6%/yr
Find: Repayment plan that is not equivalent to the others.
Looking over at each plan: (a)
End of P I P+I Amt Paid Remaining

year amount after
year n
1 10,000 600 10,600 600 10,000
2 10,000 600 10,600 600 10,000
3 10,000 600 10,600 10,600 0
Looking at plan: (b)

year amount after
year n
1 10,000 600 10,600 4,600 6,000
2 6,000 360 6,360 3,600 2,760
3 2,760 165.6 2925.6 3,600 Overpaid
Looking at plan: (c)

year amount after
year n
1 10,000 600 10,600 0 10,600
2 10,600 636 11,236 0 11,236
3 11,236 674 11,910 11,910 0
Looking at plan: (d)

year amount after
year n
1 10,000 600 10,600 3,741 6859
2 6,859 411.54 7270.54 3,741 3529.54
3 3,529.54 211.77 3741 3,741 0
Answer: Plan b is different from the others

3. At 10% interest, the cash flow below
0 1 2 3 4
P2,000
P2,500
P3,000
P3,500
is equivalent to a uniform yearly cash flow of

a) P3,500 b) P2,780 c) P2,691 d) P3,025
Solution:
i=10%/yr
0 1 2 3 4 0 1 2 3 4
P2,000
P2,500 A=?
P3,000
P3,500
1st approach: First find P, then solve for A algebraically.
P  2,000  (1.1)  2,500  (1.1)  3,000  (1.1)  3500  (1.1)
1 2 3 4
P  8,528.6
P  A  (1.1)  A  (1.1)  A  (1.1)  A  (1.1)
1 2 3 4
P  A(0.9091  0.8264  0.7513  0.683)  A  3.1698

Solving forA :
AP  P8,528.6  P 2691
3.1698 3.1698
2nd Approach; Solve for P, then find A using the capital
recovery factor interest formula.
A  P  ( A / P, i , n)
 i 1  i  
n
A  8528.6   
 (1  i )  1
n
 0.11  0.1 
4
A  8528.6   
 (1  0. 1)  1
4
A  P 2,691
3rd Approach: Use the uniform gradient interest factor formula.
A  A  G ( A / G , i, n)
1
1 n
A  A  G [  ]
i (1  i )  1
1 n
1 4
A  2,000  500  [  ]
0.1 (1  0.1)  1 4
A  P 2,691
4. Which of the following interest relationships is
not true?
a) (P/A,i,n) = [1 + (P/F,i,n)](1/i)
b) (A/P,i,n) = (A/F,i,n) + i
c) (P/F,i,n) = (P/F,i,n1)×(P/F,i,n2) provided n1 + n2 = n
d) (F/A,i,n ) = 1 + ( F/P,i,1) + (F/P,i,2) + ….. + (F/P,i,n-1)
e) none of the above

Solution: Prove each identity given, starting with (a)
?
(P/A, i, n)  [1  (P/F, i, n)](1/i)

 1  i   1
n
?
1
 i  1  i    [1  (1  i ) ]  i
n
n
 
 1  i   1 1  (1  i )
n n
?
 i  1  i    [
n
i
]
 
 1 
1 
 1  i   1  (1  i )   1  i   1
n n n
?
 i  1  i    
n
i

i  (1  i ) 
     
n
 
 1  i   1  1  i   1
n n
 i  1  i     i  (1  i ) 
n
   
n
Proving identity (b).
 A / P, i , n) ( A / F , i , n   i
?
 i  (1  i ) n
  ?
i 
 (1  i )    (1  i )  1  i
   
n n
 i  (1  i ) n
  i  i  ((1  i )  1)   i  i  (1  i )  i 
?
n n
 (1  i )   (1  i )  1  
(1  i )  1 
     
n n n
 i  (1  i )   i  (1  i ) 
n n
 (1  i )    (1  i ) 
   
n n
Proving identity c).
F=F2
F1
n=n1+n2
P n1 n2
From the cash flow diagram, we can see that

P  F ( P / F , i, n)  F ( P / F , i, n )  ( P / F , i, n )
2 2 1
Since F  F , then,
2
(P/F, i, n)  ( P / F , i, n )  ( P / F , i, n )
2 1
A
F=?
0 1 2 3 4 5 6 7 n-1 n
A  ( F / A, i, n)  A  (1  i) ( n n )
 A  (1  i) ( n  ( n 1 ))
 A  (1  i) n( n 2 )
....A  (1  i ) ( n 1 )
A  ( F / A, i, n)  A   (1  i)  (1  i )  (1  i)  ...  (1  i) 
?
0 1 2 n 1
A  ( F / A, i, n)  A  [1  ( F / P, i,1)  ( F / P, i,2)  ...(F / P, i, n  1)]

( F / A, i, n)  1  ( F / P, i,1)  ( F / P, i,2)  ...(F / P, i, n  1)
Nominal vs Effective Interest Rates
 Effective interest rate, ia, is the actual or

exact rate of interest earned on the
principal during one year.
 Nominal interest rate, r, is the customary
way of expressing interest rate that is
compounded more than once during the
year.
Nominal vs Effective Interest Rates
The relationship between effective annual interest

rate and nominal rate is given by
r
i  (1  )  1
M
M
a
where: M = number of compounding periods

per year
r = nominal rate expressed in decimal
Reviewer/Effective vs. Nominal rates/Frequent Compounding
Interest rate statement Interpretation Comment
i = 12% per year i = effective 12% per year When no compounding period
compounded yearly is given, interest rate is an
i = 1% per month i = effective 1% per month effective rate, with
compounded monthly compounding period assumed
i = 3½% per quarter i = effective 3½% per quarter to be equal to stated time
compounded quarterly period.
i = 8% per year, i = nominal 8% per year When compounding period is
compounded monthly compounded monthly given without stating whether
i = 4% per quarter the interest rate is nominal or
compounded monthly i = nominal 4% per quarter effective, it is assumed to be
i = 14% per year compounded compounded monthly nominal. Compounding period
semiannually is as stated.
i = nominal 14% per year
compounded semiannually
i = effective 10% per year i = effective 10% per year If interest rate is stated as an
compounded monthly compounded monthly effective rate, then it is an
i = effective 6% per quarter i = effective 6% per quarter effective rate. If compounding
compounded quarterly period is not given,
i = effective 1% per month i = effective 1% per month compounding period is
compounded daily compounded daily assumed to coincide with stated
time period.
Reviewer/Effective vs. Nominal rates/Frequent Compounding
Table 2. Specific examples of interest statements and interpretations.
Interest statement Type of Compounding

interest period
15% per year compounded monthly Nominal Monthly
15% per year Effective Yearly
Effective 15% per year compounded Effective Monthly
monthly
20% per year compounded Nominal Quarterly
quarterly
Nominal 2% per month Nominal Weekly
compounded weekly
2% per month Effective Monthly
2% per month compounded Effective Monthly
monthly Effective Quarterly
Effective 6% per quarter Effective Daily
Effective 2% per month
compounded daily Nominal Continuously
1% per week compounded
continuously Nominal Continuously
0.1% per day compounded
continuously
Reviewer/Effective vs. Nominal
rates/Frequent Compounding
5. In which statement is the interest rate not
given as an effective rate?
a) effective 12% per year compounded
monthly
b) 10% per year compounded daily
c) 2% per month compounded monthly

6. Which will provide the largest annual effective
rate?
a) effective 18% per year compounded yearly
b) 18% per year compounded daily
c) 17.5% per year compounded weekly
d) nominal 18.5% per year compounded semi-
annually
Reviewer/Effective vs. Nominal rates/Frequent
Compounding
Solution: a) 18%
b)
365
 0.18 
i  1    1  19.72%
 365 
a
c)
52
 0.175 
i  1    1  19.09%
 52 
a
d)
2
 0.185 
i  1    1  19.36%
 2 
a
Answer : b
7. If a borrower just made the first quarterly
payment of P700 in interest for a loan that carries
an interest rate of 2% per quarter, the original
amount of loan is:
a) P8,750.00 c) P140,000
b) P35,000.00 d) P165,000
Compounding
Given: Iq=P700
iq=2%/quarter
Solution:
For the first interest period,
I=P×i×n, where n=1
P700=P ×0.02 × 1
Solving for P,
P=P700/0.02=P35,000 b
8. Which of the following is not equivalent to 24%
per year compounded monthly?
a) 2% per month
b) effective 26.82% per year
c) 6.12% per quarter
d) 12.24% per semi-annual period
Compounding
Given: interest statement: 24%/yr compounded monthly
= 2% /month
a) 2%/month: ia=(1+0.02)12-1=26.82%
b) 26.82%/year
c) 6.12% / quarter: ia=(1+0.0612)4-1=26.82%
d) 12.24%/semiannual period:
ia=(1+0.1224)2-1=25.98%
Answer: d
9. An appliance worth P7,875 is made available for a
1 and ½ year loan, payable in monthly installments
of P500. The effective annual interest rate is closest
to
a) 12.6% b) 18.8% c) 13.5% d) 21.6%

Compounding
For this type of problem, solution is by trial and error
method, using the values in the multiple choice. It is best
to start trials with values in the middle of the range of
choices.
Try b) 18.8% i  0.188  (1  i )  1
a m
12
Solving for i :
m
0.188  1  (1  i ) m
12
1  i  (1.188)
m
( 1 / 12 )
i  1.0144595  1  1.44595%
m
Use this in the equation of value, and if it gives an

answer of 15.75, then it is the answer. Otherwise, try
the others.
Compounding
Given: P=7,875
n=1 and ½ yrs = 18 months
A=P500
Find: ia
The equation of value is
P7,875 = P500× (P/A,i,n)
  1  i '  1 
n
7,875  500   
 i '(1  i ' ) 
n
 1  i '  1  7,875
n
   15.75
 i '(1  i ' )  500
n
Compounding
  1  i '  1 
n
7,875  500   
 i '(1  i ' ) 
n
 1  i '  1  7,875
n
   15.75
 i '(1  i ' )  500
n
 1  0.144594   1   7,875  15.75

18
 
 0.144594  (1  0.144594)  500
18
Answer: b
10. How much money will be accumulated in 3 years
if a person made a monthly deposit of P2000 every
month up to the 3rd year when the account pays
interest of 1% per month?
a) P81,406 b) P90,028 c) P115,112 d) P86,154

Compounding
Given: n = 3 yrs = 36 months

Am=P2,000
i=1%/mo
Find: F F  A( F / A, i, n)
 (1  i )  1 
n
F  A 
 i 
 (1  i )  1 
n
FA m
 where n  no. of months
 i 
m
 (1  .01)  1 
36
F  P2,000     P86,154
 0.01 
Answer : d
11. How many years will be required for a given
sum of money to triple, if it is deposited in a bank
account that pays 8% per year compounded
quarterly?
a) 14 c) 13
b) 15 d) 16
Given: P
F = 3P
i=8%/yr compounded quarterly = 2%/q
Find: n such that F=3P at 2%/q

Compounding
F  3P  P  ( F / P, i , n )q q
3  (1  1 )
nq
q
3  (1  .02)
nq
To solve for n , take the natural log of both sides

q
n ln(1.02)  ln 3
q
1.0986123
n   55.48q
0.0198026
q
55.48 q  13.87 yrs  14 yrs

Compounding
Alternatively, we can solve for nyears directly by 1st
obtaining ia: i  (1  i )  1 4
a q
i  (1  .02)  1  8.2432% / yr
a
4
F  3P  P  ( F / P, i , n ) a
3  (1  1 )
n
a
3  (1  0.082432)
n
To solve for n , take the natural log of both sides

n ln(1.082432)  ln 3
1.09886123
n   13.86 yrs  14 yrs
0.0792105
yrs
12. If you invest P1,500,000 now in a house and lot,
how much must you rent your property per month
for 20 years if you want an annual return of 20% on
your investment?
a) P18,400 b) P21,450 c) P25,670 d) P30,000
Given: P=P1.5M
n = 20 yrs
i=20%/yrs Find: Am
First, find A year
A year
 P ( A / P, i , n)
 i (1  i )  n
A  P1.5M   
 (1  i )  1 
n
 0.20(1  0.20)  20
A  P1.5M     P308,034.8
 (1  0.20)  1 
20
A P308,034.8
A   year
 P 25,670 / mo
12 12
m
13. A series of equal payments of P500 is received
semi-annually for 4 years. After the first 4 years, the
semi-annual payments are doubled in size, and these
larger payments are received for 10 more years. If the
interest rate is 12% compounded quarterly, the single
present amount equivalent to the series of payments
received over the 14-year period is
a) P10,075 b) P10,114 c) P10,190 d) P11,400
Cash flow diagram:
A2s
A1s
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14
i=12% compounded quarterly

Given: A1s=P500 semi-annual payments during the first 4 yrs;
n1s=8
A2s = P1,000 semi-annual payments during the next 10 yrs;
n2s=20
Find P:
Since cash flows are semi - annual, we have to first solve for i :
s
i  (1  i )  1
s q
2
0.12
i  (1  )  1  0.0609  6.09%
2
4
s
P  A  ( P / A, i , n )  A  ( P / A, i , n )( P / F , i , n )
1s s 1s 2s s 2s s 1s
 (1  i )  1
n1 s
 (1  i )  1 n2 s
P  A    A     (1  i )  n1 s
 i  (1  i )   i  (1  i ) 
1s n1 s 2s n2 s
 (1  0.0609)  1  8
 (1  0.0609)  1  20
P  P500     P 1, 000     (1.0609) 8
 0.0609  (1  0.0609)   0.0609  (1  0.0609) 

8 20
P  P10,190
Answer: c
Reviewer/Methods of Evaluating Investment
Alternatives
Interest earned by an investment:

P=P1,000
i earned = ?
P=P1,000
P1=P500 P2=P500
i earned = ?
P=P1,000
Alternatives
Interest earned by an investment:

F1=P500 F2=P500 F3=P500
i earned = ?
F=P1,500
P=P1,000
i earned = ?
P=P1,000
Alternatives
14. The actual interest earned on an investment is
the interest rate that makes
a) the equivalent amount of receipts equal to the
equivalent amount of disbursements at time 0.
b) the equivalent amount of receipts equal to the
equivalent amount of disbursements at t = n.
c) the equivalent yearly amount of receipts equal to
the equivalent yearly amount of disbursements
d) all of the above

Alternatives
Calculations involving bonds:
A bond is a financial instrument setting forth the conditions
under which money borrowed.
Par value or face value is the value stated on the bond (as in
a check, note, bill or other paper security), usually in multiples of
P1,000.
A bond’s yield to maturity is the effective annual interest rate
earned by a bond, taking into consideration periodic interest
payments and disposal or redemption price of the bond at
maturity.
Maturity refers to the time that a bond or note is payable.
Alternatives
15. A P10,000 bond that will mature in 20 years is currently
sold for P7,500. It provides 10% interest payments paid
quarterly. The face value of the bond is
a) P7,500 c) P2,500
b) P10,000 d) none of the above

Analysis of engineering investment
alternatives
 Minimum Attractive Rate of Return
(MARR) – rate chosen by top management
of an organization to maximize its
economic well-being.
Analysis of engineering investment
alternatives
 Methods for evaluating the economic
profitability of a single proposed problem
solution or alternative
 Present worth method (PW) or net present
value (NPV) method – based on the
concept of equivalent worth of all cash
flows relative to some base or beginning
point in time called the present
Net present value or present worth method
To find PW as a function of I% of a series of cash receipts

and /or expenses, we use the following relationship:
PW(i%)  Fo (1  i) 0  (F1 (1  i) 1  F2 (1  i) 2  ...Fk (1  i)  k  ...Fn (1  i)  n
n
or PW(i%)   Fk (1  i)  k
k 0
A project is acceptable if PW > 0.

where i = effective interest rate, or MARR, per compounding period
k = index for each compounding period, (0<k<n)
Fk = future cash flow at the end of period k
n = number of compounding periods in the planning horizon
Future worth method
Future worth (FW) method – all cash inflows and outflows are compounded forward to a reference point
in time called the future
FW(i%)  Fo (1  i) n  F1 (1  i) n1  F2 (1  i) n 2  ...Fn (1  i) 0
n
or FW(i%)   Fk (1  i) nk
k 0
A project is acceptable if FW > 0.

Annual worth method
Annual worth (AW) method – the annual equivalent revenues (or savings), R, minus
annual equivalent expenses, E, less its annual equivalent capital recovery cost, CR. Its
calculation is given by
AW(i%) = R – E – CR (i%)
where CR is computed with i = MARR as follows:
CR(i%) = I×(A/P, i%, n) – S×(A/F, i%, n)
where I = initial investment for the project

S = salvage (residual) value at the end of the study period
A project is acceptable if AW > 0.

Internal rate of return
Internal Rate of Return (IRR) Method – the most widely used, also known as investor’s
method, discounted cash flow method, and profitability index. IRR is the interest rate that
equates the equivalent worth of cash inflows (receipts or savings) to the equivalent worth of
cash outflows (expenditures, including investments).
n n
R
k 0
k (P/F, i%, k)   E k (P/F, i%, k)
k 0
A project is acceptable if i% > MARR.
Benefit-cost ratio method
Benefit-cost ratio method – also known as savings investment ratio
Conventional B/C ratio
AW(benefit s of the proposed project) B

B/C  
AW(total cost of the proposed project) CR  (O & M)
Modified B/C Ratio
B - (O & M)
B/C 
CR
A project is acceptable if the B/C ratio is > 1.0.
Payback period method
Payback period method
i. Simple payback period is the smallest value of n for which the equation below is
satisfied:
n
F
t 0
t 0
ii. The discounted payback period, n’, is calculated to take into account the time
value of money as follows:
n'
 F ( P / F , i%, t )  0
t 0
t
Capitalized worth
Capitalized equivalent amount (capitalized worth) – the present worth or value of a
project that is assumed to last forever
CEA = P = A(P/A, i%, n)

As n becomes very large, (P/A, i%, n) → 1/i.
Thus, CEA = P = A/i.
Alternatives
16. After passing the board exam, you plan to set up a
business that requires a P2.5 M initial investment of which
25% is working capital. The P2.5 M also includes an amount
of P575,000 for equipment, with no salvage value. The
business is good for 7 years and is projected to provide
yearly net cash flows of P600,000. In addition, you will
recover 80% of your working capital at the end of 7 years.
At 16% interest per year, the present worth of this
investment is closest to
a) P80,000 b) P100,060 c) P150,040 d) P224,360

Alternatives
Given: P=P2.5M WC = 25% of P = 0.25 × P2.5M
n = 7 yrs WC = P625,000
A = P600,000
i= MARR = 16%/yr
SV = 80% of working capital = 0.8×P625,000=P500,000
Find: Present Worth (PW) = Net present value (NPV)
PW   P  A  ( P / A, i, n)  SV  ( P / F , i, n)
 (1  i ) n  1 n
PW   P  A     SV  (1  i )
 i  (1  i ) 
n
 (1  0.16) 7  1  7
P   P 2.5M  P 600T   7
 P 500T  (1  0.16)
 0.16  (1  0.16 ) 
P  P100,040
Alternatives
17. Given the following cash flow for an investment and a

MARR of 12%:
End of
Year 0 1 2 3 4 5 6
Cash
Flow -30,000 -19,000 10,000 10,000 10,000 20,000 20,000
The simple payback period is

a) 3 years b) 4 years c) 5 years d) 6 years

Alternatives
Simple payback period: The smallest value for which the relationship
below is satisfied: n
F  0
t 0
t
Sequentially solving for the value of ΣFt

At t  1,
1 ?
 F   P30,00  (  P19,000)  0
0
t
At t  2,
2 ?
 F   P30,000  ( P19,000)  ( P10,000)  0

0
t
At t  3,
3 ?
 F   P30,000  ( P19,000)  ( P10,000)  (10,000)  0

0
t
At t  4,
4 ?
 F   P30,000  ( P19,000)  ( P10,000)  (10,000)  (10,000)  0

0
t
Alternatives
At t  5,
5 ?
 F   P30,000  ( P19,000)  ( P10,000)  (10,000)  (10,000)  ( P 20,000)  0

0
t
5
At t  5,  F  0; n  5 yrs.
t
0
Alternatives
18. Given the following cash flow for an investment
and a MARR of 12%:
End of
Year 0 1 2 3 4 5 6
Cash
Flow -30,000 -19,000 10,000 10,000 10,000 20,000 20,000
The internal rate of return is closest to

a) 8.6% b) 9.4% c) 10.8% d) 11.3%

Alternatives
Given: MARR = 12%
n = 6 yrs
Cash flow – as given in the Table
Find: IRR
IRR is the value of the interest rate, i’, that will make the
equivalent amount of receipts equal to the equivalent amount
of disbursements:
n n
 R  ( P / F , i '%, k )   E  ( P / F , i '%, k )
k 0
k
k 0
k
Alternatives
n n
 R  ( P / F , i'%, k )  E
k 0
k
k 0
k  ( P / F , i '%, k )
10,000  ( P / A, i' ,3)  ( P / F , i' ,2)  20,000  ( P / A, i' ,2)  ( P / F , i ' ,4) 
 P30,000  P19,000  ( P / F , i' ,1)
Sequentially try the interest rate given as choices,
starting with values in the middle of the range.
Alternatives
n n
 R  ( P / F , i'%, k )  E
k 0
k
k 0
k  ( P / F , i '%, k )
10,000  ( P / A, i ' ,3)  ( P / F , i' ,2)  20,000  ( P / A, i' ,2)  ( P / F , i ' ,4) 
 P30,000  P19,000  ( P / F , i' ,1)
 (1  i' )3  1 2  (1  i ' ) 2
 1
10,000   3 
 (1  i ' )  20,000   2 
 (1  i ' ) 4

 i' (1  i ' )   i ' (1  i' ) 
P30,000  P19,000  (1  i ' ) 1 
Using i’=9.4%, equivalent receipts equal P47,368 and
equal disbursement equal P47,402. The other choices
do not come close, and the difference could be due to
rounding discrepancies. Therefore, IRR = 9.4%
Alternatives
Capital Recovery (C.R.) cost defined:
CR  P( A / P, i, n)  S ( A / F , i, n)
Alternatives
19. A machine which costs P100,000 when new has a
lifetime of 15 years and a salvage value equal to 20% of its
original cost. If interest rate is 10% compounded annually,
the capital recovery of the machine is closest to
a) P12,518 c) P15,324
b) P14,645 d) P16,846

Alternatives
Given: P=P100,000
SV = 20% of P=0.2× P100,000=P20,000
i = 10% compounded annually
n = 15 years
CR  P ( A / P, i, n)  S ( A / F , i, n)
 i (1  i ) n   i 
CR  P100,000     P 20,000   
 (1  i ) n
 1   (1  i ) n
 1 
 0.1(1  0.1)15   0.1 
CR  P100,000     P 20,000   
 (1  0.1)15
 1   (1  0 .1)15
 1 
CR  P12,518
Answer: b
Decision making among alternatives
 Investment alternative – a decision option; can consist of a group or a
set of proposals
 Engineering proposal – a single undertaking or project being
considered as an investment possibility
 Independent proposal – a proposal whose acceptance will not have
an effect on the acceptance of any of the other proposals in the set
 Mutually exclusive proposals – the acceptance of one precludes the
acceptance of any of the others
 Contingent proposal – a proposal whose acceptance is conditional on
the acceptance of the prerequisite proposal.
 For a set of proposals, the number of alternatives, A, is given by A =
2k, where k is the number of proposals.
Basic Philosophy in Comparing Alternatives
 Different levels of investment produce varying economic outcomes.
 The alternative that requires the minimum investment of capital and
produces satisfactory financial results will be chosen among mutually
exclusive alternatives unless the incremental capital associated with an
alternative having a larger investment can be justified with respect to
incremental savings or benefits.
 The base alternative is the alternative that requires the least investment
of capital that produces satisfactory results.
 Investment of additional capital over the base alternative should be
made if the extra benefits are better than those that can be obtained
from investing elsewhere.
 Investment alternatives are those with initial capital investments that
produce cash flows from increased revenues, savings through reduced
costs, or both.
 Cost alternatives are those with all negative cash flow elements except for
a possible positive cash flow element from disposal of assets at the end of
the project’s life.
Incremental Investment Analysis
Procedure:
Note: Guard against comparison involving infeasible
alternatives.
 With the lower initial cost alternative as base alternative
(Alternative A), tabulate cash flow for both alternatives in
the order of increasing initial investment.
 Calculate the difference, ∆(B-A) or the incremental cash
flow, A→B per year.
 Draw the incremental cash flow diagram.
 Determine the acceptability of the incremental cash flow.
 If the PWA→B is greater than 0, then the incremental
investment is justified and select B. Otherwise, choose A.
Reviewer/Comparison Between
Investment Alternatives
20. You are to make a choice between 2 investment alternatives as
follows: (MARR is 15% per year). The salvage value is 20% of the net cash
flow at the end of each alternative’s useful life.
End-of-Year Alternative Prime Alternative Mover
0 -P 160,000 -P240,000
1 50,000 45,000
2 50,000 45,000
3 50,000 45,000
4 130,000 45,000
5 45,000
6 45,000
7 45,000
8 100,000
Using repeatability assumption, what would be the closest

value to the PW of alternative Prime?
a) P30,286 b) P40,648 c) P44,780 d) P52,280
Comparing alternatives with
unequal lives:
 Repeatability assumption – comparison using
a common multiple of the lives of the
alternatives; economic consequences that are
estimated to happen in alternatives’ life span
will also happen in all succeeding life spans
 Co-terminated assumption – truncates to a
selected period, all alternatives to put them on
a common and a comparable basis.
Given: MARR = 15%/yr
SV = 20% of net cash flow
Find: PW of alternative Prime using repeatability assumption.
P130,000 P130,000
A=P50T
0 1 2 3 4 5 6 7 8
-P160,000 -P160,000
Reviewer/Comparison Between Investment
Alternatives
PW   P160T  P50T ( P / A,15%,8)  P80T ( P / F ,15%,4)  P80T ( P / F ,15%,8)

PW  P 44,778
Answer: c
21. Two electric motors are being evaluated for an
automated paint booth application. Each motor must have
an output of 10 horsepower (hp). It is estimated that the
booth will be operated an average of 8 hours per day for
250 days per year. MARR is 12% per year before taxes and
the machine must return the capital in 5 years. Motor A
costs P68,000 and has a guaranteed efficiency of 85% at
the indicated operating load. Motor B costs P56,000 and
has a guaranteed efficiency of 80% at the same operating
load. Electric energy costs P6.80 per kilowatt-hour and 1hp
= 0.746 kw. (Recall that efficiency equals output/input).
The annual cost of electric energy in operating motor A is
closest to
a) P119,360 b) P126,820 c) P142,320 d) P163,270
Given: For Motor A,
P=P68,000
eff = 85%
output, O = 10 hP
1 hP = 0.746 kw
electric energy cost = P6.80/kw-hr
Avg no. of hours of operation/year =
= 8 hrs/day × 250 days/yr = 2,000 hrs/year
Find: Annual cost of operating Motor A
Calculation:
output
eff 
input
output 10hP
Input    11 .764706 hP
eff 0.85
0.746kw hrs P6.80
Annual cost of electricit y  11 .764706 hP   2000  
hP yr kw  hr
Annual cost of electricit y  P119,360
Answer: a
Reviewer/Comparison Between Investment
Alternatives
SV
Unrecovered capital recovery

cost
Imputed salvage value = SV×(P/F,i,n-n’)+CR×(P/A,i, n-n’)

Reviewer/Depreciation Methods and
Taxation
22. Among the following depreciation methods, that
which will produce the lowest present worth of taxes
paid is
a) straight-line method
b) sinking fund method
c) declining balance method
d) service-output method
Depreciation and Taxation
 Depreciation (D) – the decrease in value of physical properties

with the passage of time. It is an accounting concept that
establishes an annual deduction against before-tax income
such that the effect of time on an asset’s value can be reflected
in the firm’s financial statements. It is a non-cash cost that
affects income taxes.
A property is depreciable if:
 • It is used in business or held for the production of income
 • It has a determinable life that is longer than 1 year
 • It is something that wears out, decays, get used up, becomes
obsolete, or loses value from natural causes
Depreciation and Taxation
 Market value (MV) – what will be paid by a willing buyer to a
willing seller for a property where each has equal advantage and
is under no compulsion to buy or sell.
 Salvage (SV) or residual value (RV) – the price that can be
obtained from the sale of a property after it has been used. If
used in depreciation calculations, it is referred to as estimated
salvage (ES), representing an asset’s terminal value.
 Book value (BV) – the worth of a property as shown on the
accounting records of a company; it means the original cost of
the property less all amounts that have been charged as
depreciation expenses
 Basis or cost basis (P) – also known as unadjusted cost; the cost
of acquiring an asset (purchase price) including normal costs of
making the asset serviceable
Depreciation methods
Straight line method (SLM) – assumes that a constant amount is depreciated each year over
(P - ES n )
the useful life of the asset. It is computed as D t 
n
where Dt = annual depreciation deduction in year t (1<t<n)
P = basis or cost basis
ESn = asset’s estimated salvage or terminal value
n = depreciable life of the asset in years
The cumulative depreciation through year t (D*t) is calculated as D* t  t  D t

The book value at the end of year t is calculated as BV t  P  D* t
Depreciation
In general, it is convenient to summarize the depreciation amount and the book values of an
asset during its useful life in a depreciation schedule table constructed as follows:
Asset’s life in Beginning of the Depreciation Cumulative End of the year

years year book value amount for the Depreciation book value
year
n BVt-1 Dt D*t BVt
 Declining Balance Method (DBM) – sometimes
called the percentage method, or the Matheson
formula, and assumes that the annual cost of
depreciation is a fixed percentage of the book
value at the beginning of the year.
 Depreciation rate (α) – constant ratio between the
depreciation in any one year to the beginning of
the year book value. For the double or 200%
declining balance method (DDBM), α = 2/n, or
twice the straight line rate of 1/n.
Thus the depreciation for year 1 (D1) is
given as D  α  P
1
The depreciation for any year t, Dt, is

calculated as D  α  1  α   P
t 1
*
Cumulative depreciation, D t, is
calculated as D  P  1  1  α  
* t
t
The book value at the end of year t (BVt),

is given by BV  (1  α)  P
t
t
If the fixed percentage, α, is not given, it can

be calculated and its use would result in a
book value at the end of the asset’s useful
life equal to its estimate salvage value:
1/n
 ES 
α  1  n

 P 
Sum of the years’ digits method:
Procedure:
 List the digits corresponding to the number for
each permissible year of life in reverse order.
 Determine the sum of these digits.
 For any year, the depreciation factor is the
number from the reversed-order listing for that
year divided by the sum of the digits.
 The depreciation deduction for any year is the
product of the SYD depreciation factor that year
and difference between the cost basis and the ES.
Taxation
23. A contractor imports an equipment for P1.2M.
Customs, installation and other costs initially incurred to
make the equipment serviceable amounted to P200,000.
At the end of 5 years, the equipment will have a market
value of P200,000. If depreciated by the straight-line
method, cumulative depreciation through the end of the
second year will be
a) P240,000 c) P200,000
b) P480,000 d) P400,000
Taxation
Given: B = purchase cost + installation cost
B = P1.2M + P200,000 = P1.4M
n = 5 years
S = P200,000
dep method = SLM
Find: cumulative depreciation through year 2
In the straight line method, the cumulative depreciation equals

depreciation/year times no. of years
Taxation
[B  S ]
dep / year 
n
where : B  cost basis; S  salvage value; and n  depreciable life
[ P1.4M  P 0.2M ]
dep/year   P 240T
5
depreciation through year 2  dep/year  no. of years
depreciation through year 2  P240T  2  P480,000
Answer: b
Taxation
24. An optical scanning machine that will be used for
reproducing blueprints of engineering drawings can be
purchased for P12M and has an estimated market value
of P2.4M at the end of 10 years. If the machine were to
be depreciated using declining balance method that will
result in book value equal to market value at the end of
10 years, by what rate must the machine be depreciated?
a) 18.62% c) 11.42%
b) 25.31% d) 14.87%
Taxation
Given: B=P12M
SV = P2.4M
n = 10 years
Depreciation method = declining balance
Find: R such that MV = BV at the end of 10 years
Solution:
  SV 1/ n    P 2.4 M 1/10 
R  1      1      14.87%
  B     P12M  
Taxation
25. The newly established All-Natural Drug Company is deciding
between two pill-forming machines described below:
Round Oval
First Cost P7,200,000 P4,500,000
Salvage Value 1,080,000 900,000
Annual Revenue 1,200,000 1,000,000
Less Expenses
Life, years 6 6
Using the straight line method of depreciation, an effective tax rate of

30%, and an after tax return of 20%, the amount of taxes to be paid for
the first year for the round machine is closest to
a) P80,000 b) P106,000 c) P212,000 d) P54,000
Taxation
Given: B=P7.2M
S = P1,080,000
R-E=P1,200,000
n = 6 years
depreciation method = SLM
eff tax rate = 30%
after-tax MARR = 20%
Find: Taxes paid for year 1 for the round machine
Taxation
To solve this problem, it is convenient to set up a table as
follows:
End-of- Before-tax Dep Taxable Taxes
year cash flow Income Paid
(BTCF)
1 P1,200,000 P1,020,000 P180,000 P54,000
where: Dep = (P7,200,000-P1,080,000)/6=P1,020,000

Taxable Income = BTCF-Dep= P1.2M-P1,020,000=P180,000
and Taxes Paid = Tax Rate × Taxable Income = P180,000 × 0.30 =
= P54,000
Answer: d
Taxation
26. Ferdinand Shipping Company bought a tugboat for
P750,000. This boat is expected to last for 5 years, after which
it could be sold for P120,000. The following revenues and
expenses are expected for the first operating year.
Revenues – P2,000,000
Expenses – P840,000
Depreciation – P40,000.
If the company is taxed at a rate of 30%, what is the net
income at the end of the first year?
a) P287,000 d) P268,000
b) P784,000 e) none of the above
c) P824,000
Taxation
Given: Revenues – P2,000,000
Expenses – P840,000
Depreciation – P40,000
n = 5 years
S = P120,000
tax rate = 30%
Find: net income at end of year 1

Taxation
As in the previous problem, setting up a table is a convenient
way to solve this type of problem:
End-of- BTCF Dep Taxable Taxes ATCF or
year Income Paid Net
Income
after tax
1 P1,160,000 P40,000 P1,120,000 P336,000 P824,000
where: BTCF = Revenue – Expenses = P2M-P840,000 = P1,160,000

Taxable Income = BTCF – Dep = P1,160,000 – P40,000 = P1,120,000
Taxes paid = Taxable Income × tax rate = P1,120,000 × 0.30 = P336,000
And ATCF = BTCF – Taxes Paid = P1,160,000 – P336,000 = P824,000

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Reviewer/Interest Formulas

21. (Part I) A uniform payment series is one that

a) to find F given A c) to find A given F

Plan End-of Interest Total owed at Payment

Given: 3 different plans to pay a loan as shown in the table.

P = P25M (A/P,i,n) = [i×(1+i)n] = [0.25×(1+0.25)12]

End of P I P+I Amt Remaining

End of P I P+I Amt Paid Remaining

Looking at plan: (b)

End of P I P+I Amt Paid Remaining

Looking at plan: (c)

End of P I P+I Amt Paid Remaining

Looking at plan: (d)

End of P I P+I Amt Paid Remaining

Answer: Plan b is different from the others

is equivalent to a uniform yearly cash flow of

P  A(0.9091  0.8264  0.7513  0.683)  A  3.1698

(P/A, i, n)  [1  (P/F, i, n)](1/i)

From the cash flow diagram, we can see that

A  ( F / A, i, n)  A  [1  ( F / P, i,1)  ( F / P, i,2)  ...(F / P, i, n  1)]

 Effective interest rate, ia, is the actual or

The relationship between effective annual interest

where: M = number of compounding periods

Interest statement Type of Compounding

Use this in the equation of value, and if it gives an

 1  0.144594   1   7,875  15.75

Given: n = 3 yrs = 36 months

Find: n such that F=3P at 2%/q

To solve for n , take the natural log of both sides

55.48 q  13.87 yrs  14 yrs

To solve for n , take the natural log of both sides

i=12% compounded quarterly

P  P500     P 1, 000     (1.0609) 8

 0.0609  (1  0.0609)   0.0609  (1  0.0609) 

Interest earned by an investment:

Interest earned by an investment:

To find PW as a function of I% of a series of cash receipts

A project is acceptable if PW > 0.

FW(i%)  Fo (1  i) n  F1 (1  i) n1  F2 (1  i) n 2  ...Fn (1  i) 0

A project is acceptable if FW > 0.

where CR is computed with i = MARR as follows:

CR(i%) = I×(A/P, i%, n) – S×(A/F, i%, n)

where I = initial investment for the project

A project is acceptable if AW > 0.

Conventional B/C ratio

AW(benefit s of the proposed project) B

Modified B/C Ratio

CEA = P = A(P/A, i%, n)

The simple payback period is

Sequentially solving for the value of ΣFt

 F   P30,000  ( P19,000)  ( P10,000)  0

 F   P30,000  ( P19,000)  ( P10,000)  (10,000)  0

 F   P30,000  ( P19,000)  ( P10,000)  (10,000)  (10,000)  0

 F   P30,000  ( P19,000)  ( P10,000)  (10,000)  (10,000)  ( P 20,000)  0

The internal rate of return is closest to

Using repeatability assumption, what would be the closest

PW   P160T  P50T ( P / A,15%,8)  P80T ( P / F ,15%,4)  P80T ( P / F ,15%,8)

Unrecovered capital recovery

Imputed salvage value = SV×(P/F,i,n-n’)+CR×(P/A,i, n-n’)

 Depreciation (D) – the decrease in value of physical properties

The cumulative depreciation through year t (D*t) is calculated as D* t  t  D t

Asset’s life in Beginning of the Depreciation Cumulative End of the year

The cumulative depreciation through year t (Dt) is calculated as D t  t  D t