Cash Flow Diagrams and the

Payment Series II
Linear and Geometric Gradient
Series
Take Note:
• the end-of-year convention in the cash flow
calculations does not necessarily mean
December 31

• all formulas were derived for the specific form of

the cash flow diagram
Linear Gradient Series
• payments that increase or decrease by a fixed
amount G for each period
Present Worth Factor – Linear Gradient
• factor notation: (P/G,i,N)
Example:
• A textile mill has just purchased a lift truck that has a
useful life of 5 years. The engineer estimates that the
maintenance costs for the truck during the first year will
be $1,000. Maintenance costs are expected to increase as
the truck ages at a rate of $250 per year over the
remaining life. Assume that the maintenance costs occur
at the end of each year. The firm wants to set up a
maintenance account that earns 12% interest. All future
maintenance expenses will be paid out of this account.
How much does the firm have to deposit in this account
now?

• $5,204
Gradient-to-Equal Payment Series
Conversion Factor
• factor notation: (A/G,i,N)
Example:
• John and Barbara have just opened two savings
accounts at their credit union. The accounts earn
10% annual interest. John wants to deposit $1,000
in his account at the end of the first year and
increase this amount by $300 for each of the
following 5 years. Barbara wants to deposit an equal
amount each year for the next 6 years. What should
be the size of Barbara’s annual deposit so that the
two accounts would have equal balances at the end
of 6 years?

• $1,667.08
Example (seatwork):
• Suppose that you make a series of annual
deposits into a bank account that pays 10%
interest. The initial deposit at the end of the first
year is $1,200. The deposit amounts decline by
$200 in each of the next 4 years. How much
would you have immediately after the 5th
deposit?

• $4,652
Geometric Gradient Series
• payments that increase or decrease by a fixed
rate for each period
Present Worth Factor
• factor notation: (P/A1,g,i,N)
Example:
• Jimmy Carpenter is opening a retirement account at a bank.
His goal is to accumulate $1,000,000 in the account by the
time he retires from work in 20years time. A local bank is
willing to open a retirement account that pays 8% interest,
compounded annually throughout the 20 years. Jimmy
expects his annual income will increase at a 6% annual rate
during his working career. He wishes to start with deposit at
year 1 (A1) and increase the deposit at a rate of 6% each year
thereafter. What should be the size of his first deposit? The
first deposit will occur at the end of year 1, and subsequent
deposits will be made at the end of each year. The last deposit
will be made at the end of year 20.

• $13,757
Composite Cash Flows
• Brute Force Method
• Generalized Cash Flow Technique
▫ Example: Given this cash flow diagram
Generalized Cash Flow Technique

Simple
cash flow

Simple
cash flow

Equal cash flows

Example 13**
• A couple with a newborn daughter wants to save for
their child’s college expenses in advance. The couple
can establish a college fund that pays 7% annual
interest. Assuming that the child enters college at
age 18, the parents estimate that an amount of
$40,000 per year will be required to support the
child’s expenses for four years. Determine the equal
annual amounts the couple must save until they
send their child to college.

• $4,264
Determining Interest Rate to Establish
Economic Equivalence
• You won $2M; the prize will be paid in 20
annual installments of $100K for 20 years.
Determining Interest Rate to Establish
Economic Equivalence
• Option 1 • Option 2
▫ You save your winnings for ▫ You do the reverse and spend
the first 7 years then spend for 7 years and then save for
every winnings in the 13 years
remaining 13 years (with
i=7%)
Find F and i
• F = $2,085,485 (option 1)

• F = $2,014,064 (option 2)

• Finding i using interest tables will yield,

i=6.594%
 “Fear of death increases in exact
proportion to increase in wealth.”

-Ernest Hemingway