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Geometric Gradient Series, Finishing Chapter 2

This lecture covers geometric gradient series and finishing chapter 2 of the textbook. Key points include: - Geometric gradients increase or decrease cash flows at a constant percentage rate rather than amount. - The lecture derives the present worth formula for geometric gradients and provides an example calculation. - Future worth factors for geometric gradients are also presented and worked through an example. - The lecture reminds students that interest formulas only apply when the interest period matches the compounding period. - Chapter 2 is now complete, covering all basic time value of money equations.

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Shaka Shalahuddin Shantika Putra
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210 views17 pages

Geometric Gradient Series, Finishing Chapter 2

This lecture covers geometric gradient series and finishing chapter 2 of the textbook. Key points include: - Geometric gradients increase or decrease cash flows at a constant percentage rate rather than amount. - The lecture derives the present worth formula for geometric gradients and provides an example calculation. - Future worth factors for geometric gradients are also presented and worked through an example. - The lecture reminds students that interest formulas only apply when the interest period matches the compounding period. - Chapter 2 is now complete, covering all basic time value of money equations.

Uploaded by

Shaka Shalahuddin Shantika Putra
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PPT, PDF, TXT or read online on Scribd
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Lecture 5

Geometric Gradient Series,


Finishing Chapter 2
Read 84-102
Problems 2.30, 32, 35, 38, 39, 47, 52
Do the self-test in studying for Exam.

Geometric Gradient

Increasing/decreasing at a constant
percentage, not a constant amount

g > 0, series will increase, g < 0, series will


decrease

A
A(1+g)N-1
A(1+g)
A
Or

A(1-g)
A(1-g)N-1

Present Worth Pn, of any cash


flow An, at i is:
Pn An (1 i ) n A1 (1 g ) n 1 (1 i ) n
We then apply the principle of single payment present worth to each term (P/F, i, n),
N

P A(1 g ) n 1 (1 i ) n
n 1

A(1 g) 1 , is a constant term that can be removed from the series


A N (1 g )
P

(1 g ) n 1 (1 i )
Letting a

A
1 g
and x
1 g
1 i

P a ( x x 2 x 3 .... x N ), which is the closed form of a geometric series for the first N terms
multiply by x, xP a(x 2 x 3 ... x N 1 )

Then subtract the two equations from one


another as we did in our earlier
derivations.
N 1
P xP a( x x

P(1 x) a ( x x N 1 )
a( x x N 1 )
P
, where x 1
1 x
replacing a and x for the original terms we get,
1 (1 g ) N (1 i ) N
A
P
ig
NA /(1 i ), if i g

, if i g

Geometric gradient series present worth factor


(P/A,g,i,N)
Unlike the linear gradient the annual amount
is imbedded in the equation.

Example:

Airplane ticket price will increase 8% in


each of the next four years. The cost at
the end of the first year will be $180.
How much should be put away now to
cover a students travel home at the end
of each year for the next four years?
Assume 5%.

1 (1 g ) n (1 i ) n
P A
ig

1 (1.08) 4 (1.05) 4

180
.05 .08

0.11928
180
$715.67
0.03

As a check we can also solve this problem without using the geometric
gradient
Year
Ticket
1 A1 = = 180
2 A2 = 180 + 8%(180)
= 194.40
3 A3 = 194.40 + 8% (194.50)
= 209.95
4 A4 = 209.95 + 8% (209.95)
= 226.75

P = 180(P/F,5%,1) + 194.40(P/F,5%,2) + 209.95(P/F,5%,3) +


226.75(P/F,5%,4)
=$715.66

There are no tables for the geometric gradient.

Future worth Factor


Since F =P(1+i)
n
n

(
1

g
)
(
1

i
)
n
n
Multiplying
(P/A,g,i,n)
by
(1+i)
will
give
F
F P (1 i ) A
(1 i )

(1 i ) n (1 g ) n
F A

ig

ig

Example

A graduating CE is going to make $35,000/yr


with Granite Construction. A total of 10% of
the CE salary will be placed in the mutual fund
of their choice. The CE can count on a 3%
salary increase with the standard of living
increases for the next 30 years of employment.
If the CE is aggressive and places their
retirement in a stock index fund that will
average 12% over the course of their career,
what can the CE expect at retirement?

A = 35,000 x 0.1 = 3,500


i = 12%
g = 3%
n = 30

(1 i ) n (1 g ) n
F A

ig

(1.12) 30 (1.03) 30
3500
3500 305.92 $1,070,714
0.09

Recall that all of the interest equations


can only be used when interest period is
the same as the compounding period.

Problem 2.15 revisited


Many of you solved this problem using brute force,

P = 1,000,000 + 800,000(P/F,8%,1) +.+


1,000,000(P/F,8%,10) = $6,911,539

You should just recognize that you could also solve it by

P = 1,000,000 + 800,000(P/A,8%,5) +1,000,000(P/A,8%,5)


(P/F,8%,5)

Or
P = 1,000,000 + 100,000(P/A,8%,10)
200,000(P/A,8%,5)
Recognizing multiple ways to solve a
problem will be crucial on the exam!
More Complicated Example,
Solve the following Cash Flow diagram
for Present Worth,

Chapter 2 is now complete. All of the


basic equations have been presented.

Most of the basic equations are functions


on the spread sheet programs like excel,
lotus, and there is a downloadable
program made by the author of the
textbook

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