Engineering Economy

LEARNING OUTCOMES

1. Arithmetic Gradient
Factors
2. Geometric Gradient
Factor
3. Shifted Gradients
Calculation

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 Arithmetic Gradients
Arithmetic gradients change by the same amount each period

The cash flow diagram for the PG

of an arithmetic gradient is: G starts between periods 1 and 2
PG = ? (not between 0 and 1)

1
This is because cash flow in year 1 is
2 3 4 n
usually not equal to G and is handled
0 separately as a base amount
(shown on next slide)
G
2G
3G
(n-1)G Note that PG is located Two Periods
Ahead of the first change that is equal
to G
Standard factor notation is
PG = G(P/G,i,n)
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 © 2012 by McGraw-Hill, New York, N.Y All Rights Reserved

Typical Arithmetic Gradient Cash Flow With

P =? Base Amount T

i = 10%
0 1 2 3 4 5

400
450
Amount in year 1 500
is base amount 550
600

This diagram = this base amount plus this gradient

PA = ? PG = ?
i = 10% i = 10%

+
0 1 2 3 4 5 0 1 2 3 4 5

Amount 400 400 400 400 400

50
in year 1 100
PA = 400(P/A,10%,5) PG = 50(P/G,10%,5) 150
is base 200
amount PT = PA + PG = 400(P/A,10%,5) + 50(P/G,10%,5)
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 © 2012 by McGraw-Hill, New York, N.Y All Rights Reserved

Converting Arithmetic Gradient to A

Arithmetic gradient can be converted into equivalent A value using G(A/G,i,n)
i = 10% i = 10%
0 1 2 3 4 5 0 1 2 3 4 5

G
2G A=?
3G
4G

General equation when base amount is involved is

A = base amount + G(A/G,i,n)

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 © 2012 by McGraw-Hill, New York, N.Y All Rights Reserved

Example: Arithmetic Gradient

Calculate the present and annual worth of $400 in year 1 and amounts
increasing by $30 per year through year 5 at an interest rate of 12% per year.

Solution:
PT = ? PT = 400(P/A,12%,5) + 30(P/G,12%,5)
i = 12% = 400(3.6048) + 30(6.3970)
0 1 2 3 4 5 Year = $1,633.83

400
430 The cash flow could also be converted
460
490 into an A value as follows:
G = $30 520
A = 400 + 30(A/G,12%,5)
= 400 + 30(1.7746)
= $453.24
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 Decreasing Arithmetic Gradient
For decreasing gradients,
0 1 2 3 4
change plus sign to minus

Base amount

General equation when base amount is involved is

P = base amount (P/A,i,n) - G(P/G,i,n)
A = base amount - G(A/G,i,n)

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Shifted Arithmetic Gradients

Shifted gradient begins at a time other than between periods 1 and 2

Present worth PG is located 2 periods before gradient starts

Must use multiple factors to find PT in actual year 0

To find equivalent A series, find PT at actual time 0 and apply (A/P,i,n)

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 Example: Shifted Arithmetic Gradient
John Deere expects the cost of a tractor part to increase by $5 per year beginning 4
years from now. If the cost in years 1-3 is $60, determine the present worth in year 0
of the cost through year 10 at an interest rate of 12% per year.
i = 12%
PT = ? Actual years
0 1 2 3 4 5 10
0 1 2 3 8 Gradient years
60 60 60
65
70
G=5 95 =60+(7x5)=65+(6x5)
Solution: First find P2 for G = $5 and base amount ($60) in actual year 2

P2 = 60(P/A,12%,8) + 5(P/G,12%,8) = $370.41

P0 = P2(P/F,12%,2) = $295.29
Next, move P2 back to year 0

Next, find PA for the $60 amounts of years 1 and 2 PA = 60(P/A,12%,2) = $101.41

Finally, add P0 and PA to get PT in year 0 PT = P0 + PA = $396.70

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Negative Shifted Gradients

For negative arithmetic gradients, change sign on G term from + to -

General equation for determining P: P = present worth of base amount - PG

Changed from + to -

All other procedures are the same as for positive gradients

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 Example: Negative Shifted Arithmetic Gradient
For the cash flows shown, find the future worth in year 7 at i = 10% per year
F=?
PG = ? i = 10%
0 1 2 3 4 5 6 7
Actual years
0 1 2 3 4 5 6 Gradient years
450
500
550
600
650
700

G = $-50=$50 decreasing
Solution:
PG is located in actual year 1

PG = 700(P/A,10%,6) – 50(P/G,10%,6) = 700(4.3553) – 50(9.6842) = $2565

F = PG(F/P,10%,6) = 2565(1.7716) = $4544

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Geometric Gradients
Geometric gradients change by the same percentage each period
Cash flow diagram for present worth There are no tables for geometric factors
of geometric gradient

where: A1 = cash flow in period 1

g = rate of increase

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 Decreasing Geometric Gradients

Note: If g is negative, change signs in front of both g values

Example: Geometric Gradient

Find the present worth of $1,000 in year 1 and amounts increasing
by 7% per year through year 10. Use an interest rate of 12% per year.
(a) $5,670 (b) $7,333 (c) $12,670 (d) $13,550

Pg = ? Solution:
i = 12%
1 2 3 4 10 Pg = 1000[1-(1+0.07/1+0.12)10]/(0.12-0.07)
= $7,333
0
1000
1070 Answer is (b)
1145
g = 7%

1838 To find A, multiply Pg by (A/P,12%,10)

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 Shifted Geometric Gradients
Shifted gradient begins at a time other than between periods 1 and 2

Equation yields Pg for all cash flows (base amount A1 is included)

Equation (i ≠ g): Pg = A 1{1 - [(1+g)/(1+i)]n/(i-g)}

For negative gradient, change signs on both g values

There are no tables for geometric gradient factors

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Example: Shifted Geometric Gradient

Weirton Steel signed a 5-year contract to purchase water treatment chemicals
from a local distributor for $7000 per year. When the contract ends, the cost of
the chemicals is expected to increase by 12% per year for the next 8 years. If
an initial investment in storage tanks is $35,000, determine the equivalent
present worth in year 0 of all of the cash flows at i = 15% per year.

=7000(1+0.12)8

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 Example: Shifted Geometric Gradient

Gradient starts between actual years 5 and 6; these are gradient years 1 and 2.
Pg is located in gradient year 0, which is actual year 4
Pg = 7000{1-[(1+0.12)/(1+0.15)]9/(0.15-0.12)} = $49,401
Move Pg and other cash flows to year 0 to calculate PT
PT = 35,000 + 7000(P/A,15%,4) + 49,401(P/F,15%,4) = $83,232
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Negative Shifted Gradients

For negative geometric gradients, change signs on both g values

Changed from + to -

Pg = A1{1-[(1-g)/(1+i)]n/(i+g)}

Changed from - to +

All other procedures are the same as for positive gradients

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 Example: Negative Shifted Gradients
Morris Glass Company has decided to invest funds for the next 5 years. All
cash flow estimates are in $1000 units, and the interest rate expectation is 8%
per year.
Years 1 through 5: Invest $7000 in year 1, decreasing by $1000 per year
through year 5.
Years 6 through 10: No new investment and no withdrawals.
Years 11 through 15: Withdraw $20,000 in year 11, decreasing 20% per year
through year 15.
Determine if the anticipated withdrawals will be covered by the investment

Example: Negative Shifted Gradients

Morris Glass Company has decided to invest funds for the next 5 years. All
cash flow estimates are in $1000 units, and the interest rate expectation is 8%
per year.
Years 1 through 5: Invest $7000 in year 1, decreasing by $1000 per year
through year 5.
Years 6 through 10: No new investment and no withdrawals.
Years 11 through 15: Withdraw $20,000 in year 11, decreasing 20% per year
through year 15.
Determine if the anticipated withdrawals will be covered by the investment

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 Example: Negative Shifted Gradients

Summary of Important Points

In P/A and A/P factors, P is one period ahead of first A

In F/A and A/F factors, F is in same period as last A

To find untabulated factor values, best way is to use formula or spreadsheet

For arithmetic gradients, gradient G starts 2 periods after P

Arithmetic gradients have 2 parts, base amount and gradient amount

For geometric gradients, gradient g starts 2 periods after P

In geometric gradient formula, A1 is amount in period 1

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Summary of Important Points
P for shifted uniform series is one period ahead of first A;
n is equal to number of A values

F for shifted uniform series is in same period as last A;

n is equal to number of A values

The present worth of a gradient will

always be located two periods before the gradient starts.

For negative arithmetic gradients, change sign on G from + to -

For negative geometric gradients, change sign on g from + to -

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