Gradients Formulas

Some cases periodic payment do not occurs in an uniform series, they

may be increases or decreases by constant amount
P= A (P/A. i%, n) + G (P/G, i%, n)
Pg = A1{1- [(1+g)/(1+i)]n}/(i-g)

Base amount A

G starts between
periods 1 and 2
(not between 0 and 1)
 Typical Arithmetic Gradient Cash Flow
PT = ?

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 100
PA = 400(P/A,10%,5) PG = 50(P/G,10%,5) 150
1 200
is base PT = PA + PG = 400(P/A,10%,5) + 50(P/G,10%,5)
amount
PG = ?
Arithmetic Gradient
1 2 3 4 n An arithmetic gradient is a cash flow
0 series that either increases or decreases
G by a constant amount
2G
3G
(n-1)G
P= A (P/A. i%, n) + G (P/G, i%, n)

Pg = ? Geometric gradients change by the

same percentage each period
1 2 3 4 n

0
A1
A 1(1+g)1
A 1(1+g)2 Pg = A1{1- [(1+g)/(1+i)]n}/(i-g)

A 1(1+g)n-1
 There are cases, where the periodic payments do not
occur at an equal series. These payments may increase or
decrease by a constant amount.
 For example, a series payments would be uniformly
increasing in Rs. 5,000, Rs. 5,500, Rs. 6,000 and Rs. 6,500
occurring at the end of the first, second, third and fourth
years respectively.
 Similarly, a uniformly decreasing series will be Rs. 5,000,
Rs. 4,500, Rs. 4,000 Rs. 3500 occurring at the end of first,
second, third and fourth years respectively.
 In each case, an equal-payment series provides the base
with a constant annual increase or decrease at the end of
second year.
 For example, because of leasing a certain type of
equipment, maintenance and repair savings relative to
purchasing the equipment may increase by a roughly
constant amount each period.
 This situation can be modeled as a uniform gradient of cash
flow.
 For example, if the cash flow in period 1 is $800 and in
period 2 it is $900, with amounts increasing by $100 in
each subsequent interest period, this is an arithmetic
gradients.
 There are two general types of gradients –
1. ArithmeticGradient
2. Geometric Gradient
 Arithmetic Gradient – some problems involve receipts or expenses that are
projected to increase or decrease by a constant amount each period.
 An arithmetic gradient is a cash flow series that either increases or decreases
by a constant amount

G, 2G, 3G, 4G …. (n – 1) G
 Geometric Gradient
 Refers to change by the same percentage each period
Pg = A1{1- [(1+g)/(1+i)]n}/(i-g)
where: A1 = cash flow in period 1
g = rate of increase
 If G > 0 the series is referred to as an increasing gradient series
 If G < 0 it is referred to as a decreasing gradient series.
 Please note that the first cash flow in a strict linear gradient series
is 0
Sometimes cash flows change by a constant amount each
period.
We can model these situations as a uniform gradient of cash flows. The
table below shows such a gradient.

End of Period Cash Flows

1 0
2 G
3 2G
: :
N (N-1)G

8
 Gradient Formulas
Arithmetic gradient series – Starts at base amount and increases by
constant gradient G in years 2 through n

Base
Amount
A

P = A(P/A, i%, n) + G(P/G, i% n)

This total present worth of base and gradient
 Gradient Factors
 The “G” amount is the constant arithmetic change from
one time period to the next.
 The “G” amount may be positive or negative.
 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.
 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 usually not
2 3 4 n
equal to G and is handled separately as a base
0 amount
G
(shown on next slide)
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)
Present Worth Point…

$700
$600
$500
$400
$300
$200
$100

0 X 1 2 3 4 5 6 7

The Present Worth Point of the

Gradient
• Thus, the general equation to find the
P= A (P/A. i%, n) + G (P/G, i%, n)
• Where,
P = present worth of base amount
A = amount in period 1
G = amount of change in cash flow between periods 1 and 2
n = number of periods from 1 through n of gradient cash flow
i = interest rate per period.
 Since the gradient G begins between years 1 and 2 thus is called a
conventional gradient.
 Arithmetic Gradients
Example: Estimated annual revenue is $5,000 increasing by $500 per year
starting next year. Find P and A equivalent over an 8-year period at i = 10%.
$8500

Gradient, G = $500 $8000

Find P
$7500
$7000
= 5000 (P/A, 10, 8) + 500 (P/ G 10%, 8)
$6500
= 5000 (5.3349) + 500 (16,029)
$6000
= 26.674 + 8.014
$5500 = 34,688
$5000
Base Find A
A = $5000 = 5000 + 500 (A / G, 10%, 8)
= 5,500 (3.0045)
0 1 2 3 4 5 6
= 16,524
7 8
 Example: Arithmetic Gradient
The present worth of $400 in year 1 and amounts increasing by $30 per year through year
5 at an interest rate of 12% per year is closest to:

(A) $1532 (B) $1,634 (C) $1,744 (D) $1,829

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

400 The cash flow could also be converted

430 into an A value as follows:
460
490 A = 400 + 30 (A/G,12%,5)
G = $30 520 = 400 + 30(1.7746)
= $453.24
 Example 2.
 The highway department expects the cost of maintenance for a piece of
heavy construction equipment to be $5000 in year 1, to be $5500 in year
2 and to increase annually by $500 through year 10. At an interest rate of
10% per year, determine the present worth of 10 years of maintenance
costs.
 Solution
 The cash flow includes an increasing gradient with G = $500 and a base
amount of $5000 starting in year 1.
P= A (P/A. i%, n) + G (P/G, i%, n)
P = 5000 (P/A, 10%, 10) + 500 (P/G, 10%, 10)
= 5000 (6.1446) + 500 (22.8913)
= $42.169
Example
What present amount at 10% interest, compounded annually is equivalent
to this series of payments: year 1 Rs. 9,000, year 2 Rs. 8,000, year 3 Rs.
7,000, year 4 Rs. 6,000 year 5 Rs. 5,000. Solve using the gradient factors.
9,000
8,000
7,000
6,000
5,000
P = A (P/A, i, n) – G (P/G, i, n)
= 9,000 (P/A, 10%, 5) – 1,000 (P/G, 10%, 5)
0 1 2 3 4 5 = 9,000 (3.791) – 1,000 (6.662)
= Rs. 27,457
Example
What present amount at 10% interest, compounded annually is equivalent to
this series of payments year 1 Rs. 5,000, year 2 Rs. 6,000, year 3 Rs. 7,000,
year 4 Rs.8,000, year 5 Rs. 9,000 solve using the gradient factors

P = A (P/A, i, n) + G (P/G, i, n)
9,000
= 5,000 (P/A, 10%, 5) + 1,000 (P/G, 10%, 5)
8,000
= 5,000 (3.791) + 1,000 (6.662) 7,000
6,000
= Rs. 25,617
5,000

0 1 2 3 4 5
Example: 3
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
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

Next, move P2 back to year 0

P0 = P2(P/F,12%,2) = $295.29

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

 Geometric Gradients
Geometric gradients change by the same percentage each period
Cash flow diagram for present worth
of geometric gradient
There are no tables for geometric factors
Pg = ?
Use following equation for g ≠ i:
1 2 3 4 n
Pg = A1{1- [(1+g)/(1+i)]n}/(i-g)
0
A1 where: A1 = cash flow in period 1
A 1(1+g) 1

A 1(1+g)2 g = rate of increase

Note: g starts between
If g = i, Pg = A1n/(1+i)
periods 1 and 2 A 1(1+g) n-1

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)
0 = $7,333
1000
1070
1145
Answer is (b)
g = 7%

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

End Sem Examination, April: 2022
A solid waste treatment plant has an initial investment of Rs. 10,000 lakhs, annual operation
and maintenance cost of Rs. 100 lakhs per year which increases by Rs. 10 lakhs from 5 th year
onward. Labour expenditure is estimated at Rs. 50 lakhs per year which increases by 10% from
the 2nd year onward. There are one-time expenditures of Rs. 100 lakhs at 7 th year and Rs. 300
lakhs at 16th year. Salvage value of the plant is Rs. 500 lakhs at the end of 20 years life.
Calculate the equivalent annual worth of the project at effective annual 8% interest.
November, 2022

The ABC company would like to purchase a device with an initial

investment of Rs. 60,000 and an annual operating and maintenance cost
of Rs. 5000 for a life of 5 years. The device can earn a consultancy-
based income of Rs. 18,000 in the second year, which is likely to
increase by 10 per cent annually from the third year onwards. The
salvage value of the device is Rs. 5000 at the end of its life. Perform an
annual worth analysis at an 8% interest rate and decide whether ABC
company should purchase this device.
 Example: 2
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.
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
 Arithmetic Gradient Factors
 Case 1 – Find P given G P = G (P/G, i%, n)

 Case 2 – Find F given G F= G(F/ G, i%, n)

 Case 3 – Find A given G = A = G (A/G, i%, n)

 Arithmetic Gradients
•P/G factor formula for gradient only

•A/G factor for annual equivalent of gradient only

•P/G and A/G factors are in the tables at the rear of

text
 Example 1
 As an example of the straight forward use of the gradient conversion
factors, suppose that certain EOY cash flows are expected to be $1,000 for
the second year, $2000 for the third year and $3,000 for the fourth year and
that, if interest is 15% per year, it is desired to find (P and A)
 A. Present equivalent value at the beginning of the first year
 B. Uniform annual equivalent value at the end of each of the four years.
 0 1 2 3 4
• Observe that this schedule of cash flows fits the model of the
arithmetic gradient formulas with G = $1,000 and n = 4. Note that
there is no cash flow at the end of the first period.
A. The present equivalent can be calculated as
P0 = G (P/G, 15%, 4)
= $1,000 (3.79)
= $ 3,790
B. The annual equivalent can be calculated from equation as
A = G (A/G, 15%, 4)
= $1,000 (1.3263)
= $ 1,326.30
 Of course, once Po is known, the value of A can be calculated as
A = P0 (A.P, 15%, 4)
= $3,790 (0.3503) = 1,326.30
• Present equivalent of an increasing arithmetic
gradient series

End of year Cash flows ($)

1. 5,000
2. 6,000
3. 7,000 15%

4. 8,000
 Example 1
 The schedule of cash flows is depicted in the hand diagram. The right two
diagrams show how the original schedule can be broken into two separate
sets of cash flows, an annuity series of $5,000 plus an arithmetic gradient
of $1,000 that fits the general gradient model for which factors are tabled.
The summed present equivalents of these two separate sets of cash flows
equal the present equivalent of the original problem. Thus, using the
symbols in the diagrams
 Solution
P0T = P0A + P0G
= A (P/A, 15%, 4) + G (P/G, 15%, 4)
= $5,000 (2.8550) + $1,000 (3.79)
= $ 14,275 + 3,790
= $18,065
• The annual equivalent of the original cash flows could be
calculated with the aid 0 equation
AT = A + A G
= $5,000 + 1,000 (A/G, 15%, 4)
= $5,000 + 1.3263
= $6.326.30
• AT is equivalent to POT because $6,326.30 (P/A, 15%, 4) =
18.061, which is the same value obtained previously.
• Present equivalent of a decreasing arithmetic gradient series

End of year Cash flows ($)

1. 8,000
2. 7,000
15%
3. 6,000
4. 5,000
 Example
 In the diagram show how the uniform gradient can be
broken into two separate cash-flow diagrams. In this
example, we are subtracting an arithmetic gradient of
$1,000 an annuity series of $8,000
So, POT = POA – POG
= A (P/A, 15%, 4) – G (P/G, 15%, 4)
= $8,000 (2.8550) - $1,000 (3.79)
= 22.840 – 3.790
= $19.050
$8,000
$7,000
$6,000
$5,000

1 2 3 4
$8,000

1 2 3 4
$3,000
$2,000
$1,000

1 2 3 4

BREAK DOWN OF CASH FLOWS