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Arithmetic and Geometric Gradient

1. Geometric gradients model cash flows that increase or decrease at a constant percentage each period, such as for inflation, productivity changes, or market growth. 2. The geometric gradient conversion factor calculates the present worth of a geometric gradient cash flow series based on the initial amount, growth rate, interest rate, and number of periods. 3. Care must be taken in applying the conversion factor depending on whether the growth rate is greater than, less than, or equal to the interest rate.

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Jan Christian Balunsay
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131 views

Arithmetic and Geometric Gradient

1. Geometric gradients model cash flows that increase or decrease at a constant percentage each period, such as for inflation, productivity changes, or market growth. 2. The geometric gradient conversion factor calculates the present worth of a geometric gradient cash flow series based on the initial amount, growth rate, interest rate, and number of periods. 3. Care must be taken in applying the conversion factor depending on whether the growth rate is greater than, less than, or equal to the interest rate.

Uploaded by

Jan Christian Balunsay
Copyright
© © All Rights Reserved
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
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Arithmetic and

Geometric Gradient
Reality and the Assumed Uniformity of
A, G and g
 Thereality of engineering projects is that the annual
revenues from selling a new product or annual benefits
from using a new highway change each year as demand
and traffic levels change.
 Most annual cash flows are not really uniform
 Why do we define and start with an A that is a uniform
annual cost, a G that is a uniform annual gradient, and a
g (next section) that is a uniform annual rate of
increase?
Reality and the Assumed Uniformity of
A, G and g
 It is easier to start with simpler models. We use cash
flow tables and spreadsheets when needed for more
complex models.
 These model cash flows are the basis of the formulas
and tabulated factors that are often used in engineering
economic analysis.
 Often in the real world, engineering economy is applied
in a feasibility or preliminary analysis.
Geometric Gradient
 A geometric gradient series is a series of cash flows that
increase or decrease by a constant percentage each
period.
 The geometric gradient series may be used to model
inflation or deflation, productivity improvement or
degradation, and growth or shrinkage of market size, as
well as many other phenomena.
Geometric Gradient
 The geometric gradient to present worth conversion
factor, denoted by (P/A,g,i,N), gives the present worth,
P, that is equivalent to a geometric gradient series where
the base receipt or disbursement is A, and where the rate
of growth is g, the interest rate is i, and the number of
periods is N.
Geometric Gradient
Geometric Gradient
Geometric Gradient
Care must be taken in using the geometric gradient to present worth
conversion factor. Four cases may be distinguished:
1. i > g > 0. Growth is positive, but less than the rate of interest.
The growth-adjusted interest rate, i°, is positive. Tables or functions
built into software may be used to find the conversion factor.
2. g > i > 0. Growth is positive and greater than the interest rate.
The growth-adjusted interest rate, i°, is negative. It is necessary to
compute the conversion factor directly from the formula.
Geometric Gradient
3. G = i > 0. Growth is positive and exactly equal to the interest
rate. The growth adjusted interest rate, i°, equals zero. As with any
case where the interest rate is zero, the present worth of the series
with constant terms, A/(1 g ), is simply the sum of all the N terms:

4. g < 0. Growth is negative. In other words, the series is


decreasing. The growth adjusted interest rate, i°, is positive. Tables
or functions built into software may be used to find the conversion
factor.
Geometric Gradient

Where: = total cash flow in period 1


g = rate of change per period (decimal form)
i = interest rate per period
Geometric Gradient

When g = i, the P value is


Sample Problem
A mechanical contractor has four employees whose
combined salaries through the end of this year are
$250,000. If he expects to give an average raise of 5%
each year, calculate the present worth of the employees’
salaries over the next 5 years. Let i =12% per year.
Sample Problem
The first-year maintenance cost for a new car is
estimated to be $100, and it increases at a uniform
rate of 10% per year. Using an 8% interest rate,
calculate the present worth (PW) of the cost of the
first 5 years of maintenance.
Sample Problem
Chemical engineers at a Coleman Industries plant in the Midwest
have determined that a small amount of a newly available chemical
additive will increase the water repellency of Coleman’s tent fabric
by 20%. The plant superintendent has arranged to purchase the
additive through a 5-year contract at $7000 per year, starting 1 year
from now. He expects the annual price to increase by 12% per year
starting in the sixth year and thereafter through year 13. Additionally,
an initial investment of $35,000 was made now to prepare a site
suitable for the contractor to deliver the additive. Use i = 15% per
year to determine the equivalent total present worth for all these cash
flows.
Basics for Gradients
 Arithmetic gradients consist of two parts: a uniform series that has an A value equal to
the amount of money in period 1, and a gradient that has a value equal to the change in
cash flow between periods 1 and 2.
 For arithmetic gradients, the gradient factor is preceded by a plus sign for increasing
gradients and a minus sign for decreasing gradients.
 Conventional arithmetic and geometric cash flows start between periods 1 and 2, with
the A value in each equation equal to the magnitude of the cash flow in period 1 and the
P value in year 0.
 Geometric gradients are handled with the equations presented above, which yield the
present worth of all the cash flows.
Spreadsheet and Calculator Functions
That Determine Factor Values
Quiz Time !!!
Proper Solving Format
1. Fold your paper lengthwise
2. On topmost left part of your paper, write your Last Name, First Name Middle
Initial (e.g. Dela Cruz, Juan C.) and your section
3. Below your name, write your ID no. and the date of the quiz.
4. Below your ID no., write the activity and number (e.g. Quiz #1)
Dela Cruz, Juan A. BSEE-3A
19-00001 10/13/22
Quiz #1.

5. Write neatly as possible in your solution sheets.


6. Write the given, required, cash flow diagram and solution.
7. Always box your final answers and affix your signature beside it. (Note: When
you already box your final answer, there must be no erasures inside the box.)
8. Finally, you must submit your solution sheets in PDF format 5 minutes before
the set deadline. No extension will be given.

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