ENGR 3360U Winter 2014

Unit 4.5-6
Arithmetic and Geometric Gradients
Dr. J. Michael Bennett, P. Eng., PMP,
UOIT,
Version 2014-I-01

Unit 4 Interest and Equivalence

Change Record
2014-I-01 Initial Creation
Text references: Chapters 3 and 4

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2014-I-01

Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 4 Interest and Equivalence

4.5 Arithmetic Gradient

Suppose that our A increases at a fixed amount
every year.
A, A+10, A+20,.
We call this the Arithmetic Gradient
The A is the same.
The Gradient is called G
(note confusion with geometric gradient (next))

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Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 4 Interest and Equivalence

Arithmetic Gradient Factors(P/G) and (A/G)

A1+(n-1)G

Cash flow (CF) profile

A1+(n-2)G

Find P, given gradient cash flow G

A1+2G

Base amount
= A1

1
n

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A1+G

n-1

CFn = A1 (n-1)G
Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 4 Interest and Equivalence

Gradient Example

$700
$600
$500
$400

$300
$200

$100

1
7

Gradients have two components:

1. The base amount and the gradient
2. The base amount (above) = $100/time period

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Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 4 Interest and Equivalence

Gradient Components
Find P of gradient series
1G

(n-3)G

(n-2)G

(n-1)G

2G

0G
Base amount
per period

..

0
n

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)
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Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 4 Interest and Equivalence

Gradient Decomposition
As we know, arithmetic gradients are
comprised of two components
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)
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Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 4 Interest and Equivalence

Derivation Summary for (P/G)

Start with:
P G ( P / F , i, 2) 2G ( P / F , i,3) 3G ( P / F , i, 4) ...

+[(n-2)G](P/F,i,n-1)+[(n-1)G](P/F,i,n)

(1)

Multiply (1) by (1+i)1 to create a second equation

Subtract (1) from the second equation and simplify
Yields
G (1 i ) 1
n
P=

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

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(1 i) in 1

2
n
i
(1

i
)

(P/G,i,n) factor
No Excel relation exists

Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 4 Interest and Equivalence

Use of the (A/G) Factor

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

(n-1)G

(n-

Find A, given gradient cash flow G

A
A

2)G

...

2G
G

Equivalent A
of gradient
series

CFn = (n-1)G
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Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 4 Interest and Equivalence

Example
CN Rail is considering the deposit of $500,000 in an account for
the repair of old and safety-questionable bridges in British
Columbia. Further they estimate that the deposits will increase
by $100,000 per year for only 9 years thereafter, and then cease.
Determine (a) present worth and (b) annual series amounts that
would give the same result if the funds earn interest at 5% per
year.

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Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 4 Interest and Equivalence

Solution
Two cash flows must be made and added: the first for the present
worth of the base amount PA and a second for the present worth
of the gradient, PG
Therefore PT = PA + PG
= 500(P/A, 5%, 10) + 100(P/G, 5%, 10)
= 500(7.7217) + 100(31.652)
= $7026.05 ($7,026,050)
To calculate the equivalent annual series,
AT = PT (A/P, 5%, 10) = 7026.05(0.12950)
= $909.87 ($909,870)
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2014-I-01 Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 4 Interest and Equivalence

4.6 Geometric Gradient Series Factor

Geometric Gradient
Cash flow series that starts with a base amount A1
Increases or decreases from period to period by 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

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Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 4 Interest and Equivalence

A1(1+g)n-1

Typical Geometric Gradient

Given A1, i%, and g%

A1
0
n

A1(1+g)

A1(1+g)
2

n-2

n-1

Required: Find a factor (P/A,g%,i%,n) that will convert future

cash flows to a single present worth value at time t = 0
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Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 4 Interest and Equivalence

Basic Derivation: Geometric Gradient

Start with:

A1
A1 (1 g ) A1 (1 g ) 2
A1 (1 g ) n 1
Pg

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

(1)

Factor out A1 out and re-write

1
(1 g )1 (1 g ) 2
(1 g ) n 1
Pg A1

...

2
3
(1

i
)
(1

i
)
(1

i
)
(1 i ) n

(2)

Multiply by (1+g)/(1+i) to obtain Eq. (3 )

(1+g)
(1+g)
1
(1 g )1
(1 g ) 2
(1 g ) n 1
Pg
A1

...

(1+i)
(1+i) (1 i )
(1 i ) 2
(1 i ) 3
(1 i) n

(3)

Subtract Eq. (2 ) from Eq. (3 ) to yield

(1 g ) n
1
1+g

Pg
1

n 1
1 i
1+i

(1 i )

1 g
1

1 i
ig

Solve for Pg and simplify to

yield.

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Pg A1

gi

Unit 4 Interest and Equivalence

Two Forms to Consider

1 g
1

ig

Pg A1

gi

Case: g i

nA1
Pg
(1 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
No tables available to tabulate this factortoo many combinations of i
% and g% to support tables
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Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 4 Interest and Equivalence

Example 4-13
The first year maintenance cost of a new car
is $100. It increases 10% per year
thereafter.
Using a rate of 8%, what is the present
value of 5 years of maintenance?

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Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 4 Interest and Equivalence

Solution 1: by hand
Year
1
2
3
4
5

4-17

Main Cost
100.00
110.00
121.00
133.10
146.41

2014-I-01

(P/F, 8%, n)
.9259
.8573
.7938
.7350
.6808

PW
92.59
94.30
96.05
97.83
99.65
480.42

Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 4 Interest and Equivalence

Solution 2: by formula
P = A(1 ((1+g)/ (1+i))n/(i-g)
P = 100(1-((1.1)/(1.08))5/(-0.02) = 480.42

0.1-18

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Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco