GEOMETRIC GRADIENT

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Example - Increasing Geometric Gradient

A mechanical contractor is trying to calculate the present worth of

personnel salaries over the next five years. He has four employees
whose combined salaries thru the end of this year are $150,000. If
he expects to give each employee a raise of 5% each year, the
present worth of his employees' salaries at an interest rate of 12%
per year is nearest to:

(A) $591,000 (B) $816,100 (C) $702,900 (D) $429,300

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Geometric Gradients Change by the Same Percentage Each Period

Cash Flow Diagram for Present Worth of Geometric Gradients is as follows:

P=? There are no Tables for Geometric Factors

1 2 3 4 n Use Following Equation:
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A P=A{1-[(1+g)/(1+i)]n}/(i-g)
A(1+g)1 Where: A=Cash Flow in Period 1
A(1+g)2
g=Rate of increase
A(1+g)n-1
If g=i, P=An/(1+i)
Note: If g is negative, change signs in front of both g’s
Example: Find the present worth of $1,000 in year 1 and
amounts increasing by 7% per year thru year 10.
Use an interest rate of 12% per year.
(a) $5,670 (b) $7,335 (c) $12,670 (d)$13,550

Solution: P=1000[1-(1+0.07/1+0.12)10]/(0.12-0.07)
= $7,333

Answer is (b)
EXAMPLE - DECREASING GEOMETRIC GRADIENT
The Cement Factory Case

Now let’s go back to the proposed Houston American Cement plant in

Georgia. The revenue series estimate of $50 million annually is quite
optimistic, especially since there are many other cement product plants
operating in Florida and Georgia on the same limestone deposit. (The website
for the HAC plant shows where they are located currently; it is clear that keen
competition will be present.) Therefore, it is important to be sensitive in our
analysis to possibly declining and increasing revenue series, depending
upon the longer-term success of the plant’s marketing, quality, and
reputation. Assume that revenue may start at $50 million by the end of the
first year, but then decreases geometrically by 12% per year through year 5.
Determine the present worth and future worth equivalents of all revenues
during this 5-year time frame at the same rate used previously, that is, 10%
per year. 10
SOLUTION

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EXAMPLE:
A plant engineer has arranged to purchase a certain chemical
through a 5-year contract at $ 7,000 per year, starting one year
from now. He expects the annual price to increase by 12%
per year thereafter for the next 8 years. Additionally, an initial
investment of $35,000 was made to prepare a site suitable for
the contractor to deliver the chemical. Using an annual
interest rate of 15% determine the equivalent total present
worth for all these cash flows.

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3 POINTS EACH, TOTAL OF 12 POINTS , USE GRSA
Method

1 POINT FOR DRAWING OF CASH FLOW DIAGRAM

1 POINT FOR SOLUTION
1 POINT FOR ANSWER
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1 Income from sales of by-products at a small meat packing
plant have been increasing by 10% each year. If the sales in year
1 were $22,000, what is the present worth of sales for years 1 thru
8 at an interest rate of 10% per year?

(A) $160,000
(B) $180,000
(C) $200,000
(D) $220,000

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2. Transportation costs at a medium-size appliance distributor
have been increasing by 9% per year. The company expects this
year's cost to be $25,000. Find the equivalent present worth of
the costs for years 1 thru 10 at an interest rate of 12% per year.

(A) $166,720
(B) $242,660
(C) $198,140
(D) $176,390

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EOY1 - End of Year 1

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4. Juan Masipag, a self-employed individual, is opening a
retirement account at a bank. His goal is to accumulate
Php 1,000,000 in the account by the time he retires from
work in 20 years time. A local bank is willing to open a
retirement account that pays 8% interest compounded
annually throughout the 20 years. Juan expects that his
annual income will increase by 6% yearly during his working
career. He wishes to start with a deposit at the end of year 1
(A1) and increase the deposit at a rate of 6% each year
thereafter. What should be the size of his first deposit (A1)?
The first deposit will occur at the end of year 1, and the
subsequent deposits will be made at the end of each year.
The last deposit will be made at the end of year 20.

ANSWER: Php 13,757

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NEXT TOPIC: DEPRECIATION

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