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4 Linear and Geometric Gradient Cash Flows

This document covers the concepts of linear and geometric gradient cash flows, detailing how each cash flow series increases by a fixed amount or a constant percentage, respectively. It includes learning outcomes, required readings, and assignments for the week, along with examples illustrating how to calculate present worth and convert gradient series into uniform cash flows. Additionally, it touches on irregular series cash flows and methods for evaluating their present worth.

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3 views11 pages

4 Linear and Geometric Gradient Cash Flows

This document covers the concepts of linear and geometric gradient cash flows, detailing how each cash flow series increases by a fixed amount or a constant percentage, respectively. It includes learning outcomes, required readings, and assignments for the week, along with examples illustrating how to calculate present worth and convert gradient series into uniform cash flows. Additionally, it touches on irregular series cash flows and methods for evaluating their present worth.

Uploaded by

gwccqzfshy
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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Week 4: Linear and Geometric Gradient Cash Flows Getting Started

Introduction

This week we'll learn about patterns in cash flow series:

linear gradient: when each cash flow in a series increases (or decreases) by a fixed amount

geometric gradient: a series of cash flows that increase or decrease by a constant percentage each period

Learning Outcomes Checklist

At the end of this module, you will be able to To complete this module, make certain that
answer the questions: you complete the following tasks:

1. Read Chapter 2: The Time Value of


1. What are the common types of interest Money pages 40-56 in the online
formulas used to facilitate the calculation Course Textbook.
of economic equivalence?
2. Complete and submit Assignment 2:
Linear Gradient Cash Flows and Economic Equivalence
(https://e.centennialcollege.ca/d2l/common/dialogs/quickLink
Geometric Gradient
which is due at the end of this week.
Irregular Series

Readings

For this week, please read Chapter 2: The Time Value of Money pages 40-56 in the online Course
Textbook.

Due this week

Assignment 2: Cash Flows and Economic Equivalence


(https://e.centennialcollege.ca/d2l/common/dialogs/quickLink/quickLink.d2l?ou=612738&type=content&rcode=CENCOL-2976665) is due at
the end of this week.
Week 4: Linear and Geometric Gradient Cash Flows Discover & Learn

Linear Gradient Series

One common pattern of variation in cash flows occurs when each cash flow in a series increases (or decreases)
by a fixed amount. The cash flow diagram produces an ascending (or descending) straight line. Linear gradient
series are:

Present-Worth Factor: Linear Gradient (P/G,i,N)

Gradient-to-Equal-Payment Series Conversion Factor (A/G,i,N)

Note that in a Linear Gradient Series, the cash flow in period 1 is zero. The cash flows in periods 2 through N
increase at a constant amount:

Present-Worth Factor
Present-Worth Factor Linear Gradient is used when it is necessary to convert a gradient series into a present
value cash flow:

Example: Linear Gradient: Find P, Given A1, G, i, and N


The maintenance costs for a truck during the first year will be $1,000 and are expected to increase at a
rate of $250 per year. The firm wants to set up a maintenance account that earns 12% annual interest.
How much does the firm have to deposit in the account now?

Solution

Given: A1 = $1000, G = $250, i =


12%, and N = 5 years

Gradient-to-Equal-Payment Series Conversion Factor


Gradient-to-Equal-Payment Series Conversion Factor is used when it is necessary to convert a gradient series
into a uniform series of equal cash flows:
Example: Linear Gradient: Find A, Given A1, G, i, and N

Solution

Given: A1 = $1000, G = 300, i =


10%, and N = 6 years

Example: Declining Linear Gradient Series: Find F, Given A1, G, i, and N


Solution

Given: A1 = $1200, G = -200, i = 10%, and N = 5 years


Week 4: Linear and Geometric Gradient Cash Flows Discover & Learn

Geometric Gradient Cash flow

Geometric Gradient Cash flow is a series of cash flows that increase or decrease by a constant percentage
each period. Price changes caused by inflation are a good example of a geometric gradient series. We use g to
designate the percentage change in a payment from one period to the next.

Present-Worth Factor: (P/A1,g,i,N)


The present worth of a geometric series is

where A1 is the cash flow value in year 1 and g is the growth rate.
Please note, that it is not as convenient to use the table for the Geometric Gradient series cash flow. With the
formula, obey the brackets/parenthesis and exponential math. Also, do realize that if the interest rate is
equal to the growth rate, the formula is simplified as shown.

There is a way to use the tables, but it involves a pre-calculation that we will discuss later.

Example: Geometric Gradient: Find P, Given A1, g, i, and N

Current System

Because of leaks, the compressor is expected to run 70% of the time that the plant will be in operation
during the upcoming year. This will require 260 kWh of electricity at a rate of $0.05/kWh. (Plant runs 250
days a year, 24 hours per day). With current air delivery system, the compressor run time will increase
by 7% per year for the next five years.

New System
Suppose that you can replace all of the old piping now at a cost of $28,570. The compressor will still run
the same number of days; however, it will run 23% less because of the reduced air pressure loss. No
annual increase.
Do the numbers indicate that the old system should be replaced?

Solution

Given: Current power consumption, g = 7%, i = 12%, and N = 5 years

Find: A1, P

Power cost/year (A) = 70% x 250 days/year x 24 hrs/day


x 260 kWh x $0.05/kWh
= $54,440
The net cost for not replacing the old system now is $71,174 ($222,283 - $151,109). Since the new
system costs only $28,570, the replacement should be made now.

Example: Geometric Gradient: Find A1, Given F, g, i, and N

Given: F = 1,000,000, g = 6%, i


= 8%, and N = 20 years Find: A1

Solution
Week 4: Linear and Geometric Gradient Cash Flows Discover & Learn

Irregular Series Cash Flows

Irregular series cash flows are just that: "irregular"; not linear or geometric. As we've done in the past, one
could just take each cash flow and calculate its contribution to the Present Worth, Future Worth, or Annual
Equivalent Worth (depending on what method you're using). As some of the exercises ask, you may want to see
if you can see "patterns" within the cash flow series that can be grouped together as Gradient Series, Equal
Payment Series, etc. and thereby reduce the number of Interest Factors you must look up in the table.

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