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