Chapter 3

ECONOMIC STUDY METHODS (Gradients Examples)

3.1 ARITHMETIC GRADIENTS

An arithmetic gradient series is a cash flow series that either increases or decreases by a constant amount
each period. The amount of change is called the gradient.

Arithmetic gradients are defined as either a progressive increase or decrease in the flow of funds at
the end of each period for (n) periods. The amount the flow of funds increases or decreases is a constant
amount in each period. Figure 3.1 shows a cash flow diagram for an arithmetic gradient.

Figure 3.1 Cash flow diagram for an arithmetic gradient.

In Figure 3.1 (G) equals the annual arithmetic change in the magnitude of receipts or disbursements.
For an arithmetic gradient, the number of payment or disbursement periods (n-1) since the arithmetic
gradients start two years after equation time zero (ETZ). In Figure 3.1, if a line is drawn from the beginning
of the gradient to the end at year four, it demonstrates that the gradient actually starts increasing in year 1;
therefore, ETZ for the gradient is year zero and the number of periods is the number of gradients plus 1.
Figure 3.2 represents the same gradient shown in Figure 3.1, but it uses a line to represent the gradient of
separate, increasing arrows.

Figure 3.2 Cash flow diagram for an arithmetic gradient decomposed into annuities.
3.2 FUTURE WORTH OF ARITHMETIC GRADIENTS (F/G)

The equation for solving for the future worth of an arithmetic gradient, the future worth gradient
factor (F/G). Equation 3.1 is the formula for calculating the future worth of an arithmetic gradient:

Equation 3.2 is the formula for solving for the future worth of a gradient using the interest factor tables:

Example 1: Calculating the future worth of an arithmetic gradient.

A construction firm invests its profits over five years. It makes an investment at year two of $50,000.00
that increases by $50,000.00 up until year five. If the interest rate is 6%, what is the future worth of the
invested profits? Construct a cash flow diagram for the gradient investment.

Given: G = $50,000.00
i = 6%
n=5
Required: F = ?
Solution:
Cash Flow Diagram

Calculate the future worth of the gradient

Case Study
A civil engineer plans on completing his PhD in four years. During the four years of his education, he will
be earning $20,000.00 per year as a research assistant. His first year is paid for by a scholarship, but his
expenses for subsequent years will be $10,000.00 for the second year, $20,000.00 for the third year, and
$30,000.00 for the fourth year. The engineering student would like to have $50,000.00 remaining when he
graduates in four years so he needs to determine whether he will have enough funds remaining with his
projected expenses if the interest rate is 10%. Solve for the future worth of the income and expenses at the
end of four years. Given the cash flow diagram for funding the PhD.

Given: A = $20,000.00
G = $10,000.00
i = 10%
n=4
Required: F4
Solution:
1st: Calculate the future worth of the uniform annual series of $20,000.00
(1 + 𝑖)𝑛 − 1
𝐹4 = 𝐴[ ]
𝑖
(1 + 0.10)4 − 1
𝐹4 = $20,000.00[ ]
0.10
𝐹4 = $92,820.00
2nd: Calculate the future worth of $10,000.00 arithmetic gradient
1 (1 + 𝑖)𝑛 − 1
𝐹4 = 𝐺[( ) − 𝑛]
𝑖 𝑖
1 (1 + 0.10)4 − 1
𝐹4 = $10,000.00[( ) − 4]
0.10 0.10
𝐹4 = $64,100.00

3rd: Solve the total future worth by subtracting the future worth of the arithmetic gradient from the future
worth of the annuity:
𝐹4 = 𝐹𝐴 − 𝐹𝐺
𝐹4 = $92,820.00 − $64,100.00
𝐹4 = $28,720.00 Answer

An arithmetic gradient series is a cash flow series that either increases or decreases by a constant amount
each period. The amount of change is called the gradient.

3.3 PRESENT WORTH OF ARITHMETIC GRADIENTS (P/G)

The present worth of a gradient series could also be viewed as a series of increasing or decreasing
future values; therefore, the formula for the present worth of a gradient is based on summing up all of the
future values and the derivation of the present worth gradient factor formula (P/G) as shown equation

The formula for solving for the present worth of an arithmetic gradient using the interest factor

Figure below shows a cash flow diagram for solving for the present worth of an arithmetic gradient.

Example:

A nuclear engineer has to determine the amount of money her firm may borrow to purchase a new machine
if the firm is able to start repaying the loan by paying $10,000.00 in year until year six with an interest rate
of 10%. Figure below is the cash flow diagram for the new machine.
Given: G = $10,000.00
i = 10%
n = 6 years
Required: Po
Solution:
𝐺 (1 + 𝑖)𝑛 − 1 𝑛
𝑃𝑜 = [ 𝑛
− ]
𝑖 𝑖(1 + 𝑖) (1 + 𝑖)𝑛
10,000 (1 + 0.10)6 − 1 6
𝑃𝑜 = [ 6
− ]
0.10 0.10(1 + 0.10) (1 + 𝑖)6
𝑃𝑜 = $96,842.00