2.

5 Arithmetic Gradient Factors

(P/G) and (A/G)
A1+(n-1)G

Cash
C h flow
fl profile
fil

A1+(n-2)G

Find P, given gradient cash flow G

A1+2G

Base amount
= A1

A1+G

n-1

CFn = A1 (n-1)G
(n 1)G
1

Professor D. J. Lee's Engineering Economics (KHU, 2011)

Gradient Example
p

$700
$600
$500
$400

$300
$200

$100

Gradients have two components:

p
- The base amount (A1 =$100) and the gradient (G=$100)

Professor D. J. Lee's Engineering Economics (KHU, 2011)

Gradient Components
p
(n-3)G

Find P of gradient series

1G

(n-2)G

(n-1)G

2G

0G
Base amount = A / period

..
0

n-2

n-1

Present worth point is 1 period to the left of the 0G cash flow

For present worth of the base amount, use the P/A factor (already known)
For present worth of the gradient series, use the P/G factor (to be derived)
3

Professor D. J. Lee's Engineering Economics (KHU, 2011)

(P/G)) Factor Derivation

P=G(P/F,i,2)+2G(P/F,i,3)+
P
G(P/F i 2) 2G(P/F i 3)
...+ (n-2)G(P/F,i,n-1)+(n-1)G(P/F,i,n)}
P=G{(P/F,i,2)+2(P/F,i,3)+
P=G{(P/F
i 2)+2(P/F i 3)+
...+ (n-2)(P/F,i,n-1)+(n-1)(P/F,i,n)}

Professor D. J. Lee's Engineering Economics (KHU, 2011)

(P/G)) Factor Derivation

Professor D. J. Lee's Engineering Economics (KHU, 2011)

(P/G)) Factor Derivation

[[2]] [[1]]

Professor D. J. Lee's Engineering Economics (KHU, 2011)

(P/G)) Factor Derivation

1
1
1
1
n
Pi G

2
n 1
n
n
i
1

(
1
)
(
1
)
(
1

i
)
(
1

i
)

G (1 i ) n 1
n
P

n
n
i i (1 i )
(1 i )
(P/G, i%, n) factor
7

Professor D. J. Lee's Engineering Economics (KHU, 2011)

Gradient Decomposition
p
As we know, arithmetic gradients are
comprised
p
of two components
p
1. Gradient component

2. Base amount

When working with a cash flow containing a

gradient, the (P/G) factor is only for the
gradient component
Apply the (P/A) factor to work on the base
amount component
P = PW(gradient) + PW(base amount)
8

Professor D. J. Lee's Engineering Economics (KHU, 2011)

Use of the ((A/G)) Factor

(n-1)G

(n-2)G

Find A, given gradient cash flow G

A

...

2G

Equivalent A of
gradient series

n-1

A = G(A/G,i,n)
9

Professor D. J. Lee's Engineering Economics (KHU, 2011)

(A/G)) Factor Derivation

A/G converts a linear gradient to an equivalent
annuity cash flow.

A G( P / G, i, n)( A / P, i, n)
G (1 i) n 1
n i(1 i) n
A

n
n
n
i i(1 i)
(1 i) (1 i) 1
10

Professor D. J. Lee's Engineering Economics (KHU, 2011)

(A/G)) Factor Derivation

G (1 i ) n 1
n i (1 i ) n
A

n
n
n
i i (1 i )
(1 i ) (1 i ) 1

((A/G,i,n)
/ ,, ) =

n
A G

n
i (1 i ) 1
11

Professor D. J. Lee's Engineering Economics (KHU, 2011)

Example
Consider the following cash flow

$500

$400
$300
$
$200
$100

Present Worth Point is here!

And the G amt. = $100/period

Find the present worth if i = 10%/yr; n = 5 yrs

1-12

Professor D. J. Lee's Engineering Economics (KHU, 2011)

Example
First,
First The Base Annuity of $100/period

1-13

Professor D. J. Lee's Engineering Economics (KHU, 2011)

Example
$400
$300
$0

$100

$200

1-14

Professor D. J. Lee's Engineering Economics (KHU, 2011)

Example
PW(10%)Base Annuity = $379.08
PW(10%)Gradient Component= $686.18
Total
T t l PW(10%) = $379.08
$379 08 + $686.18
$686 18
Equals $1065.26
Note: The two sums occur at t =0 and can be
added together concept of equivalence

1-15

Professor D. J. Lee's Engineering Economics (KHU, 2011)

Shifted Gradient Example

Consider the following Cash Flow
0

$450
$500
$600

$550

1 This is a shifted
1.
shifted negative,
negative decreasing
gradient.
2. The PW point in time is at t = 3 (not t = o)
1-16

Professor D. J. Lee's Engineering Economics (KHU, 2011)

Shifted Gradient Example

Consider the following Cash Flow
0

$450
$500
$600

$550

The PW @ t = 0 requires getting the PW @ t =3;

Then using the P/F factor move PW3 back to t=0
1-17

Professor D. J. Lee's Engineering Economics (KHU, 2011)

Shifted Gradient Example

1-18

Professor D. J. Lee's Engineering Economics (KHU, 2011)

2.6 Geometric Gradient Series Factor

Geometric
G
ti G
Gradient
di t
Cash flow series that starts with a base amount A1
Increases
I
or decreases
d
f
from
period
i d to
t period
i d by
b a

constant percentage amount

This uniform rate of change defines
A GEOMETRIC GRADIENT
Notation:

g = the constant rate of change, in decimal form, by which

future amounts increase or decrease from one time
period to the next
p
19

Professor D. J. Lee's Engineering Economics (KHU, 2011)

A1(1+g)n-1

Typical
yp
Geometric Gradient

Given A1, i%, and g%

A1

A1(1+g)

A1(1+g)2

....
0

n-2

n-1

A1
A1 (1 g ) A1 (1 g )2
A1 (1 g )n1
Pg

...
1
2
3
((1 i)
(1
( i)
((1 i)
(1
( i )n
20

Professor D. J. Lee's Engineering Economics (KHU, 2011)

Geometric Gradients Derivation

21

Professor D. J. Lee's Engineering Economics (KHU, 2011)

Geometric Gradients Derivation

1+g
(1

g
)
1

Pg
1 A1

n1
1 i
1+i
(1 i)
22

Professor D. J. Lee's Engineering Economics (KHU, 2011)

Geometric Gradient: i g Case

1 g n
1

1 i

Pg A1
gi
ig

This is the (P/A,g,i,n) factor and is valid if g is

not equal to i.
23

Professor D. J. Lee's Engineering Economics (KHU, 2011)

Geometric Gradient: i = g Case

1
1
1
1
Pg =A1

...

(1+i)
(1+i) (1+i) (1+i)

nA1
Pg
(1 i)

For the case i = g

24

Professor D. J. Lee's Engineering Economics (KHU, 2011)

Geometric Gradients: Summaryy

1 g n
1

i
1
gi
Pg A1
ig

nA1
Pg
(1 i)

Case: g = i

Case: g = i

To use the (P/A,g%,i%,n) factor

A1 is the starting cash flow
There is NO base amount associated with a geometric gradient
The remaining cash flows are generated from the A1 starting value
25

Professor D. J. Lee's Engineering Economics (KHU, 2011)

Geometric Gradient: Notes

One will not find tabulated tables for the (P/A,
( / ,
g,i,n) factor.
You have to calculate either from the closed
form for each problem or apply a preprogrammed spreadsheet model to find the
needed
eeded factor
acto value
a ue
No spreadsheet built-in function for this factor!

26

Professor D. J. Lee's Engineering Economics (KHU, 2011)

Example
p 2.11
Assume maintenance costs for a p
particular
activity will be $1700 one year from now.
Assume an annual increase of 11% per year
over a 6-year time period. (thus the total
duration of study peroid is 7 yrs)
If
If th
the iinterest
t
t rate
t is
i 8% per year, determine
d t
i
the present worth of the future expenses at time
t = 0.
First, draw a cash flow diagram to represent the
model.
27

Professor D. J. Lee's Engineering Economics (KHU, 2011)

Example
p 2.11
g = +11% p
per p
period;; A1 = $
$1700;; i = 8%/yr
/y

28

Professor D. J. Lee's Engineering Economics (KHU, 2011)

Example
p 2.11
P=$
$1,700(P/A,g=11%,i=8%,n=7)
,
( / ,g
,
,
)
Need to calculate the P/A factor from the
closed-form expression for a geometric gradient.

1 g n
1

1
i

gi
Pg A1
ig

29

Professor D. J. Lee's Engineering Economics (KHU, 2011)

2.7 Determination of Unknown Interest

Rate
Class of problems where the interest rate, i%,
i the
is
th unknown
k
value
l
Termed, rate of return analysis(Chapter 7)

For simple,
simple single payment problems (i.e.,
(i e P
and F only), solving for i% given the other
parameters is not difficult
p
For annuity and gradient type problems,
solving for i% can be tedious
Trial and error method
Apply spreadsheet models
30

Professor D. J. Lee's Engineering Economics (KHU, 2011)

Example
p 2. 12
Assume one can invest $
$3000 now in a venture
in anticipation of gaining $5,000 in five (5) years.
What interest rate equates these two cash flows?
$5,000

$3,000

31

Professor D. J. Lee's Engineering Economics (KHU, 2011)

2.8 Determination of Unknown Number of

Years
Some problems require knowing the number of
time periods required given the other parameters

32

Professor D. J. Lee's Engineering Economics (KHU, 2011)

Example
p 2. 14
How long
g will it take for $
$1,000
,
to double in
value if the discount rate is 5% per year?
Solving we have

Fn = $2000

i = 5%/year; n is unknown!
0

...

. . . .

P = $1
$1,000
000

F
Fn=? = 1000(F/P,5%,x): 2000 = 1000(1.05)x
33

Professor D. J. Lee's Engineering Economics (KHU, 2011)

Example
p 2. 14
Solving
g we have

34

Professor D. J. Lee's Engineering Economics (KHU, 2011)