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# 1

PRINCIPLES OF MONEY-TIME
RELATIONSHIPS

Chapter # 3
2
Learning Objectives

Present value calculation for a
Examples

Definition: A collection of end-of-period, increasing cash
payments or receipts arranged in a uniformly increasing series.
The uniform increase in each successive payment is called the

Consider a 4-yr period of uniformly increasing cash flows:

3G Note: for n periods, there are (n-1) terms for G
2G |
G | |
0 | | |
0.....1..2.....3..4
|
|
|
| F

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A uniform
increasing amount.
The first cash flow
is always equal to
zero.
G = the difference
between each cash
amount.
G = \$10
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Example
Maintenance and repair expenses on
specific equipment that increase at a
relative constant amount
Leasing a certain equipment
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The G amount is the constant arithmetic
change from one time period to the next.
The G amount may be positive (receipts) or
negative (expense)!
The present worth point is always one time
period to the left of the first cash flow in the
series or,
Two periods to the left of the first gradient
cash (G) flow!
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8/15/2013
Blank & Tarquin: 5-th Edition Ch. 1
Authored by: Dr. Don Smith Texas A&M
University 7
An arithmetic (linear) Gradient is a cash flow
series that either increases or decreases by a
contestant amount over n time periods.
A linear gradient is always comprised of TWO
components:
The base annuity component
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8/15/2013
Blank & Tarquin: 5-th Edition Ch. 1
Authored by: Dr. Don Smith Texas A&M
University 8
Assume the
following:
0 1 2 3 n-1 N
A
1
+G
A
1
+2G
A
1
+n-2G
A
1
+n-1G
This represents a positive, increasing arithmetic gradient
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9
The Base Annuity
= \$1500
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8/15/2013 10
The Base Annuity
= \$1500
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Uniform Series
Decompose the cash flows into a uniform series
Present Value of the gradient to the Present
Value of the Uniform series

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\$1,000
\$1,250
\$1,500
\$1,750
\$2,000
1 2 3 4 5
0
P =?
How much do you have to deposit
now in a savings account that
earns a 12% annual interest, if
you want to withdraw the annual
series as shown in the figure?
Example Present value calculation for
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Method 1:
\$2,000
\$1,000
\$1,250
\$1,500
\$1,750
1 2 3 4 5
0
P =?
\$1,000(P/F, 12%, 1) = \$892.86
\$1,250(P/F, 12%, 2) = \$996.49
\$1,500(P/F, 12%, 3) = \$1,067.67
\$1,750(P/F, 12%, 4) = \$1,112.16
\$2,000(P/F, 12%, 5) = \$1,134.85
\$5,204.03
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Method 2:
P P A
1
000 12%,5
604 80
=
=
\$1, ( / , )
\$3, .
P P G
2
12%,5
599 20
=
=
\$250( / , )
\$1, .
P = +
=
\$3, . \$1, .
\$5,204
604 08 599 20
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A pure gradient (uniformly increasing amount) can
also be converted into the equivalent present value
of uniform series:

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

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( )
(

+
=
2
1 1
i
ni i
G F
n
Example: For 6% interest rate over 4 yr. and G of \$200,

F = \$200[(1.06)4 - 1 4(.06)] / (.06)2 = \$200(6.2436)
= \$1248.72

Recall the single payment present-worth expression:

Substitute the gradient expression for F:

present-worth factor

( )
( )
|
|
.
|

\
|
+
(

+
=
n
n
i
i
ni i
G P
1
1 1 1
2
( )
(

+
=
n
i
F P
1
1
( )
( )
(

+
+
=
n
n
i i
ni i
G P
1
1 1
2

Our firm has purchased a photocopy machine that will require increasing service/
maintenance costs over the next six years (at which time we will sell it and buy a new
one). Such costs at the end of yr. 1 will be \$100 and thereafter increase by \$50 each
subsequent year (total is \$1350). Our plan is to make these payments by using
amounts based on an initial cash deposit in an investment account in the local credit
union paying 4% annual interest. What is the required initial deposit?
250
200 |
150 | |
100 100 100 100 100 100 100 | | |
| | | | | | 50 | | | |
| | | | | | 0 | | | | |
0....1.2..3.4..5.6 + 0....1.2.3..4.5..6
| |
| |
| P
A
| P
G

P =

P
A
+P
G
= \$100[P/A, 4%, 6]+\$50[P/G, 4%, 6] = \$100(5.242)+\$50(12.506)
P = \$524.20 + \$625.30 = \$1149.50
Example:

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Solution: The cash flow diagram is as follows:
0

1 2 3 Year
430
460
4
490
520
P=?
5
400
i=12%
G = 30
P=400(P/A,12%,5) + 30(P/G,12%,5)
=400(3.6048) + 30(6.3970)
= \$1,633.83
Example: The Present Worth of \$400 in year 1 and amounts increasing by
\$30 per year thru year 5 at an interest rate of 12% per year is:
(a) \$1532 (b) \$1,634 (c) \$1,744 (d) \$1,829
The cash flow could also be converted into an A value as follows:
A = 400 + 30(A/G,12%,5)
= 400 + 30(1.7746)
=\$453.24
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Points to Remember
Money has a time value because it can
earn more money over time.
Economic equivalence exists between
individual cash flows and/or patterns of
cash flows that have the same value.
Even though the amounts and timing of
the cash flows may differ, the appropriate
interest rate makes them equal.
The purpose of developing various
interest formulas was to facilitate the
economic equivalence computation.
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Assignment
Do examples 3-7, 3-8, 3-10,3-12, 3-
13 to be submitted on Tuesday
27-2-2010