ANNUITIES AND

CAPITALIZED
COST
GE301: ENGINEERING ECONOMY

ANNUITY

A series of equal payments made at equal intervals of time

Annuities occur in the following instances:
Payment of a debt by series of equal payments at equal
intervals of time
Accumulation of a certain ammount by settling equal amounts
periodically
Substitution of a series of equal amounts periodicall in lieu of
a lump sum at retirement of an individual

Types of Annuities
Ordinary Annuity

Is on where the equal payments are made at the end of

each payment period starting from the first period.

Deferred Annuity

Payment of the first amount is deferred a certain number

of periods after the first

Annuity Due

Payments are made at the start of each period,

beginning from the first period

Perpetuity

The payment periods extend forever or in which the

periodic payments continue indefinitely

ORDINARY ANNUITY
(P/A, i%,
N)

(F/A, i%,
N)
2

Payment
Periods
3

n-1 n

Let

A = amount of each payment of an ordinary

annuity
P = present value of the n A payments
F = future worth or accumulated amount of
the n A payments
Then
P = A(P/A,i%,n) = ]
F = A(F/A,i%,n) = ]

DEFERRED ANNUITY
k|(P/A, i%,
N)

(P/A, i%, N)

A
Deferment, k
periods

k
B 0

k+1 k+2
2
1

n-1
Ordinary annuity, n
periods

k+n
n

Deferred annuity, (k+n)

periods

If each payment is A, then the present value of

the deferred annuity is
k|P = A(P/A, i%, N) (P/F, i%, k)

ANNUITY DUE
(P/A, i%, N)

(F/A, i%, N)

-1
A0

n-1

Annuity due, n periods

(n+1) periods

If each payment is A, then the present value of

the deferred annuity is
P = A(P/A, i%, n) = A[ 1 + (P/A, i%, n-1)]
F = A(F/A, i%, n) = A[ (F/A, i%, n+1) - 1]

PERPETUITY
(P/A, i%, )

A0

n-1

Perpetuity, n =

If each payment is A, then the present value for

a perpetuity
P = (P/A, i%, ) =
P=

Sample Problems

Example 1.
Determine the value of each of the following
annuity factors
(a) (P/A, 4%, 8)
(c) (F/A, 9.8%, 21)
(b) (A/P, 14.5%, 10)(d) (A/F, 6.3%, 15)

Example 2.
A steam boiler is purchased on the basis of guaranteed performance.
However, initial tests indicate that the operating cost will be P400
more per year than guaranteed. If the expected life is 25 years and
money is worth 10%, what deduction from the purchase price would
compensate the buyer for the additional operating cost?
Example 3.
A farmer bought a farm and he paid P10,000 cash and agreed to pay
P2,000 at the end of each 6 months for 5 years. He failed to pay the
first 5 payments. At the end of 3 years, he is required to pay the
seller the entire debt consisting of his accumulated and future
liabilities, otherwise the farm would be for closed by the seller. What
must he pay if money is worth 12% compounded semi-annually?

Sample Problems

Example 4.
How much money would you have to deposit for five
consecutive years starting one year from now if you want to
be able to withdraw P50,000 ten years from now? Assume the
interest is 14% compounded annually.
Example 5.
A corporation will make the following reimbursements:
P50,000 on Dec. 31, 1991
P100, 000 on Dec 31, 1992
P200,000 on Dec 31, 1993
To accumulate these sums, a sinking fund is established by
making equal year-end deposits starting Dec. 31, 1986 up to
end of 1993. If the fund earns 9% interest compounded
annually, what is the required amount of the annual deposit?

Example 6.
A man invests P10,000 now for the college
education for his 2-year old son. If the fund earns
14% effective, how much will the son get each year
starting from his 18th to the 22nd birthday?

Sample Problems

Example 7.
A person buys a piece of property for P100,000 down payment and
ten deferred semi-annual payments of P8,000 each starting three
years from now. What is the present value of the investment if the
rate of interest is 12% compounded semi-annually?

Example 8.
A farmer bought a tractor costing P25,000 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
Example 9. the amount of each installment.
A man invests P10,000 now for the college education for his A
certain manufacturing plant is being sold and was submitted for
bidding. Two bids were submitted by interested buyers. The first
bid offered to pay P200,000 each year for 5 years, each payment
being made at the beginning of each year. The second bidder
offered to pay P120,000 the first year, P180,000 the second year,
and P270,000 each year for the 3 years, all payments being made
at the beginning of each year. If money is worth 12% compounded
annually, which bid should the owner of the plant accept.

CAPITALIZED COST

The
capitalized cost of any structure or property
(equipment, machinery, building, etc.) is the sum of its first
cost and the present worth of all costs for replacement,
operation, and maintenance for a long time or forever
Capitalized cost = First Cost + Cost of Perpetual Maintenance
= FC +
Capitalized Cost =
Where:
S = the amount needed to replace or maintain the property
every k periods

CONTINUOUS COMPOUNDING FOR

DISCRETE
PAYMENTS
r

e =1+i
i = 1 er
(P/A, r%, n) = =
(F/A, r%, n) =

Sample Problems

Example 10.
If the money is worth 8% compounded quarterly,
compare the present values of the following:
a) An annuity of P1,000 payable quarterly for 50 years;
b) An annuity of P1,000 payable quarterly for 100 years;
c) A perpetuity of P1,000 payable quarterly.

Example 11.
It costs P50,000 at the end of each year to maintain
a section of Kennon road in Bagiuo City. If money is
worth 10%, how much would pay to spend
immediately to reduce the annual cost to P10,000?
Example 12.
To maintain a bridge, P5000 will be required at the
end of 3 years and annually thereafter, If money is
worth 8%, determine the capitalized cost of all
future maintenance.

Sample Problems

Example 13.
The capitalized cost of a piece of equipment was found to
be P142,000. the rate of interest used in the
computations was 12%, with salvage value of P10,000 at
the end of a service life of 8 years. Assuming that the
cost of perpetual replacement remains constant,
determine the original cost of the equipment.
Example 14.
Compare the capitalized costs of the following road pavements:
An asphalt pavement costing P100,000 which would last for 5
years with negligible repairs. At the end of 5 years, P5,000
would be spent to remove the old surface before P100,000 is
spent again for a new surface.
A thick concrete pavement costing P250,000 which would last
indefinitely, with a cost of P20,000 for minor repairs at the end
of every 3 years. Money is worth 8% compounded annually.