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(3 Credit Hours)

ARITHMETIC GRADIENT

2/15/2016

(P/G, A/G)

• Cash flows that increase or decrease by a constant amount

are considered arithmetic gradient cash flows.

$2000 Gradient

$175 $1500 series

$150 $1000 could be

$125

$100 $500 both: cash

inflow (as

given

0 1 2 3 4 0 1 2 3 4 here) or

Outflows

G = $25 G = -$500

Base = $100 Base = $2000

(P/G, A/G)

cannot apply Single Amount Present

Worth/Future Worth factors or Uniform

Series factors

address problems related to gradient cash

flows.

2/15/2016

related problems

calculated as follows:

1. Find the gradient and base

2. Cash flow diagram maybe helpful if you draw it

3. Break the gradient series into a Uniform series and a

Gradient Series as shown on next slide

4. The formula for calculating present value of the

Arithmetic Gradient series is as follows;

PT = PA + PG

5. Calculate PA and PG and use the above formula to

get the present value of the Arithmetic Gradient

(P/G, A/G)

• The base amount is “A” and the “Gradient is “G” in the

following graph

Cash Flow Formula CFn = base amount + (n-1)G

Important!!!

PG series start

A+(n-1) G with year 2

A+3G

(n-1)G

A+2G

3G

A+G 2G

A A A A A A

G

= + 0

0 1 2 3 4 n 0 1 2 3 4 n

0 1 2 3 4 n

PT = PA + PG

2/15/2016

(P/G, A/G)

PT = PA + PG

• PA = A(P/A, i, n) or Uniform Series Present worth

Factor

Worth Factor … you can use table for it too.

following formula

G (1 i ) n in 1

G (1 i ) n 1 n

PG

PG Or i i 2 (1 i ) n

i i (1 i ) n

( 1 i)n

(P/G, A/G)

Equivalent cash flows:

$175

$150

$125 $75

$100 $100 $50

$25

=> +

0 1 2 3 4

0 1 2 3 4 0 1 2 3 4

Note: Annuity series (PA) Note: the gradient series

G = $25 (PG) by convention starts

starts from year 1.

Base = $100 in year 2.

PT = PA + PG

G (1 i )n 1 n

PG

i i (1 i )n (1 i )n

$P = $100(P/A,i,4) + $25(P/G,i,4)

Where PA = Present worth uniform series (P/A, i,n) and PG = present worth of the gradient series (P/G,i, n)

2/15/2016

Profits from recycling paper, cardboard, aluminium,

and glass at a liberal arts college have increased at a

constant rate of $1100 in each of the last 3 years.

If this year’s profit (end of year 1) is expected to be

$6000 and the profit trend continues through year 5,

(a) what will the profit be at the end of year 5 and

(b) what is the present worth of the profit at an interest

rate of 8% per year?

(a) what will the profit be at the end of year 5 &

(b) what is the present worth of the profit at an interest rate of 8% per

year?

$4400

$10400 $6000 $3300

$2200

$9300 $1100

$8200 => +

$7100 0 1 2 3 4 5

0 1 2 3 4 5

$6000

PT = PA + PG

0 1 2 3 4 5 P = A(P/A, i, n) + G(P/G, i, n)

Find the cash flows as follows: P = 6000(P/A, 8%, 5) + 1100(P/G, 8%, 5)

CF = Base + G(n-1) P=

CF1 = 6000 + 1100(1-1)= 6000

6000(3.9927) + 1100(7.3724)

CF2 = 6000 + 1100(2-1)= 7100

CF3 = 6000 + 1100(3-1)= 8200

CF4 = 6000 + 1100(4-1)= 9300 P = 32066

CF5 = 6000 + 1100(5-1)= 10400

2/15/2016

Neighboring parishes in Louisiana have agreed to pool

road tax resources already designated for bridge

refurbishment. At a recent meeting, the engineers

estimated that a total of $500,000 will be deposited at

the end of next year into an account for the repair of

old and safety-questionable bridges throughout the area.

Further, they estimate that the deposits will increase

by $100,000 per year for only 9 year thereafter, then

cease. Determine the equivalent: present worth, if public

funds earn at a rate of 5% per year.

5% Uniform Series Factors Athematic Gradient

n Sinking Compound Capital Present Gradient Gradient

Fund Amount Recovery Worth Present Worth Uniform

(A/F) (F/A) (A/P) (P/A) (P/G) Series (A/G)

9 0.09069 11.0266 0.14069 7.1078 26.1268 3.6758

10 0.07950 12.5779. 0.12950 7.7217 31.6520 4.0991

Solution

• Base = 500,000 PT = PA + PG

• Gradient = 100,000 PT = 500(P/A,5%,10) + 100(P/G,5%,10)

• Taking units in 1000 = 500(7.7217) + 100(31.6520)

=$7026.05 or ….. ($7,026,050)

• Base = 500

• Gradient =100 0 1 2 3 4 5 6 7 8 9 10

• i= 5%

$500

• n=1+9 = 10 $600

$700

$800

$900

$1000 $1100

$1200

$1300

$1400

P=?

2/15/2016

Series Factor (A/G)

worth Factor

• Following formula:

AT = AA + AG

AA = A (Annual Worth) Given as base value of G series and AG = G(A/G, i, n)

factor tables or through = −

given formula in box (1 + ) −1

2/15/2016

2/15/2016

road tax resources already designated for bridge

refurbishment. At a recent meeting, the engineers

estimated that a total of $500,000 will be deposited at

the end of next year into an account for the repair of

old and safety-questionable bridges throughout the area.

Further, they estimate that the deposits will increase

by $100,000 per year for only 9 year thereafter, then

cease.

Determine the equivalent: Annual series amount, if

public funds earn at a rate of 5% per year.

Solution

AT = AA + AG

• Base = 500,000

AT = 500 + 100(A/G,5%,10)

• Gradient = 100,000 = 500 + 100(4.0991)

• Taking units in 1000 =$909.91 or ….. ($909,910)

• Base = 500 0 1 2 3 4 5 6 7 8 9 10

• Gradient =100

• i= 5% $500

$600

$700

• n=1+9 = 10 $800

$900

$1000 $1100

$1200

$1300

$1400

0 1 2 3 4 5 6 7 8 9 10

A= $909,910

2/15/2016

Worth Factor (F/G)

• Another factor in “Gradient family” is “Future” worth

of an Arithmetic Gradient series (F/G)

• It can be obtained by multiply (P/G) and (F/P) factors

1 (1 + ) −1 × =

/ = −

No factor table values is available so only formula can be use for calculating “F/G” factor

divide the gradient into two separate cash flows like Present worth of

Arithmetic gradient series…. This F/G will be the future value of entire

gradient series.

Gradient

Present Worth(PW) or Annual Worth(AW) of Arithmetic Gradient (P/G

or A/G)

…. Base and Gradient considered separately for both P/G and A/G

…. Get Two series… a PA/AA series and one PG/AG series

….use the factor tables to get values for P A/AA & PG/AG

…… Add both to get PT/AT.

… Base and Gradient are not considered separately

…. No factor values are available so have to relay on formula

….formula directly calculate the future worth of Arithmetic Gradient

1 (1 + ) −1

/ = −

2/15/2016

(Pg /A)

• A Geometric gradient is when the periodic payment is

increasing (decreasing) by a constant percentage:

• the rate at which the cash flow is increasing is “g”

• The initial amount of Geometric Gradient is A1

• Pg is the present worth of entire Gradient Series including A1

separately while working with “Geometric Gradient”

for g ≠ i: for g = i:

1+ =

1− 1+ 1+

=

−

(Pg /A)

• A Geometric gradient is when the periodic payment is

increasing (decreasing) by a constant percentage: A (1+g)n-1

1

A1 = $100, g = 10% or 0.1

A2 = $100(1+g)

A (1+g)2

A3 = $100(1+g)2 A1 (1+g) 1

A1

An = $100(1+g)n-1

0 1 2 3 4 ……n

where: A1 = cash flow in period 1 and g = rate of increase

It maybe noted that A1

for g ≠ i: is not considered

separately in geometric

1+ for g = i: gradients

1− 1+

= =

− 1+

2/15/2016

(A/G) from Geometric Gradient

Series

Geometric Gradient

Gradient and then can use F/P factor for

calculating future value of a geometric gradient

calculate the Annual worth/Annuity series from

Geometric Gradient

Determine the present worth of a geometric

gradient series with a cash flow of $50,000 in

year 1 and increases of 6% each year

through year 8. The interest rate is 10% per

year.

for g ≠ i:

1+ for g = i:

1− 1+

= =

− 1+

2/15/2016

Determine the present worth of a geometric

gradient series with a cash flow of $50,000 in

year 1 and increases of 6% each year

through year 8. The interest rate is 10% per

year.

1 1 0 .6

8

1 1 g

n

1 0 .743

Pg A 1 i 50000 1 0 .10

0 .10 0 .06

50 ,000

ig 0 .04

0 .257

50 ,000 50 ,000 ( 6 .425 )

0 .04

$ 321 , 250

Summary of all

Factors!!!

2/15/2016

F=?

F/P Factor

F= P(F/P, i%, n)

n and i is given

P is given

P/F Factor

P =? P= F(P/F, i%, n)

n and i is given

F = given

P = A(P/A, i%, n) A = P(A/P, i%, n)

F = A(F/A, i%, n) A = F(A/F, i%, n)

2/15/2016

Athematic Gradient

FG = ?

F = PT(F/P, i%, n)

or

PA = A(P/A, i%, n) 1 (1 + ) −1

/ = −

PG = G(P/G, i%, n)

Athematic Gradient

A = PT(A/P, i%, n)

or

AT = AA + AG

PA = A(P/A, i%, n) AA = A (Annual Worth) &

AG = G(A/G, i, n)

PG = G(P/G, i%, n) 1

= −

(1 + ) −1

2/15/2016

Geometric Gradient

Fg = ?

Pg = ?

1+

1− 1+ Similarly …

=

−

for g = i:

= A = Pg(A/P, i%, n)

1+

Chapter 3

Combining Factors

and Spreadsheet

Functions

Engineering Economy

2/15/2016

2. Shifted series and single cash flows

3. Shifted gradients

Example

0 1 2 3 4 5 6 7 8 9 10 11 12 13

Year

P=? A = $50

F

P3 = ?

• Use the P/F factor to find the present worth of each disbursement at year 0 and add

them.

• Use the F/P factor to find the future worth of each disbursement in year 13, add

them, and then find the present worth of the total, using P/F= F( P/F, i ,13).

• Use the F/A factor to find the future amount F/A =A( F/A, i ,10), and then compute

the present worth, using P/F=F(P/F, i ,13).

• Use the P/A factor to compute the “present worth” P3 =A( P/A , i ,10) (which will be

located in year 3, not year 0), and then find the present worth in year 0 by using the

(P/F , i ,3) factor.

2/15/2016

• Typically the last method is used for calculating the present worth

of a uniform series that does not begin at the end of period 1.

beginning of the first series amount. Why? Because the P/A factor

was derived with P in time period 0 and A beginning at the end of

period 1.

is improper placement of P .

Remember:

• When using P/A or A/P factor, PA is always one year ahead of first A

• When using F/A or A/F factor, FA is in same year as last A

• The number of periods n in the P/A or F/A factor is equal to the number of uniform

series values

of first A

0 1 2 3 4 5 6 7 8 9 10 11 12 13

Year

A = $50

P3 = ?

0 1 2 3 4 5 6 7 8 9 10 11 12 13 Year

A = $50 F=?

The number of periods n in the P/A or

F/A factor is equal to the number of

uniform series values

2/15/2016

Shifted Cash Flows

2. Locate the present worth or future worth of each series on

the cash flow diagram.

3. Determine n for each series by renumbering the cash flow

diagram.

4. Draw another cash flow diagram representing the desired

equivalent cash flow. (Optional)

5. Set up and solve the equations.

Example

The offshore design group at Bechtel just purchased

upgraded CAD software for $5000 now and annual

payments of $500 per year for 6 years starting 3 years

from now for annual upgrades. What is the present

worth in year 0 of the payments if the interest rate is

8% per year?

Solution 1. Draw a diagram of the positive and negative cash flows.

2. Locate the present

worth or future worth of

each series on the cash

i= 8% per year flow diagram.

0 1 2 3 4 5 6 7 8 Year

PA = ? 0 1 2 3 4 5 6 n

P’A = ?

PT = ? A = $500 3. Determine n for each

series by renumbering the

P0 = $5000 cash flow diagram.

2/15/2016

and solve

the P = P' ( P /F ,8%, 2)

A A

equations.

P = $500( P /A ,8%,6) ( P /F ,8%, 2)

A

PT = P0 +PA

=5000 + 500( P /A ,8%,6)( P / F ,8%,2)

=5000 +500(4.6229)(0.8573)

$6981.60

Calculate the present worth of the cash flow shown below at i = 10%

i = 10%

0 1 2 3 4 5 6 Actual year

A = $10,000

d Amount Worth Fund Amount Recovery Worth

(F/P) (P/F) (A/F) (F/A) (A/P) (P/A)

1 1.1000 0.9091 1.00000 1.0000 1.10000 0.9091

5 1.6105 0.6209 0.16380 6.1051 0.26380 3.7908

2/15/2016

Calculate the present worth of the cash flow shown below at i = 10%

i = 10%

0 1 2 3 4 5 6 Actual year

0 1 2 3 4 5 Series year

P’A = ? A = $10,000

PT = ?

Solution

(1) Use P/A factor with n = 5 (for 5 arrows) to get P’A in year 1 ---- A(P/A,10%, 5)

(2) Use P/F factor with n = 1 to move P’A back for PT in year 0 ---- (P/F,10%, 1)

PT = A(P/A,10%, 5) (P/F,10%,1)

= 10,000(3.7908)(0.9091)

$34462

Single Amounts

• For cash flows that include uniform series and randomly placed

single amounts:

Uniform series procedures are applied to the series amounts

• The resulting values are then combined per the problem statement

2/15/2016

Example

Find the present worth in year 0 for the cash flows shown using an interest

rate of 10% per year.

i = 10%

0 1 2 3 4 5 6 7 8 9 10

A = $5000

Solution: $2000

i = 10%

Actual year

0 1 2 3 4 5 6 7 8 9 10

0 1 2 3 4 5 6 7 8

Series year

A = $5000

PT = ? $2000

• Locate the present worth/ future worth

• Determine the “n” by re-numbering the cash flows series

• Uniform series procedures are applied to the series amounts. Single amount

formulas are applied to the one-time cash flows

• The resulting values are then combined per the problem statement

Example:

PT = ? PA = ?

Move PA back to year 0 using P/F: P0 = 26,675(P/F,10%,2) = 26,675(0.8264) = $22,044

Move $2000 single amount back to year 0: P2000 = 2000(P/F,10%,8) = 2000(0.4665) = $933

Now, add P0 and P2000 to get PT: PT = 22,044 + 933 = $22,977

2/15/2016

An engineering company lease the mineral rights to a mining

company on its land. The engineering company makes a

proposal to the mining company that it pay $20,000 per year for

20 years beginning 1 year from now, plus $10,000 six years from

now and $15,000 sixteen years from now. If the mining company

wants to pay off its lease immediately, how much should it pay

now if the investment is to make 16% per year?

16% Single Payments Uniform Series Factors

Amount (F/P) (P/F) Recovery (A/P) (P/A)

6 2.4364 0.4104 0.27139 3.6847

7 2.8262 0.3538 0.24761 4.0386

16 10.7480 0.0930 0.17641 5.6685

17 12.4677 0.0802 0.17395 5.7487

20 19.4608 0.0514 0.16867 5.9228

Solution

0 1 2 3 4 5 6 7 16 17 18 19 20

A =$20,000

P=?

$10,000

$15,000

P = 20,000(P/A ,16%,20)+

10,000( P /F ,16%,6) +

15,000(P/F,16%,16)

P = $20,000(5.9288)+ $ 10,000( 0.4104) + $ 15,000(0.0930)

= $124,075

2/15/2016

of Shifted Gradient Series

• Must use multiple factors to find P in actual year 0, for shifted

gradient series

located two periods before the gradient starts.

all the n periods, first find the present worth of the gradient at

actual time 0, then apply the (A/P, i, n) factor.

and then using F/P factor

Solution

For the cash flows shown, find the future value in year 7 at i = 10% per year

i = 10%

0 1 2 3 4 5 6 7

Actual years

Set up the

0 1 2 3 4 5 6 Gradient years

equations

only… 500

450

550

PG = ? P’G 600

700

650 F=?

G = $-50

Solution: PG is located in gradient year 0 (actual year 1); base amount of $700 is in gradient years 1-6

P’G = A(P/A,10%,6) – G(P/G,10%,6)

P’G = 700(P/A,10%,6) – 50(P/G,10%,6) = 700(4.3553) – 50(9.6842) = $2565

PG= P’G(F/P,10%,1) = 2565(0.9091) = $2331.84

2/15/2016

but not Standard methods)

Method 3

Method 4

So for ….

1. Introduction

What is Economics? Economics for Engineers ?

What is Engineering Economy ? Performing Engineering Economy

Study ?

Some Basic Concepts Utility & Various cost concept, Time value of

money (TVM), Interest rate and Rate of Returns, Cash Flow, Economic

Equivalence, Minimum Attractive Rate of Return, Cost of Capital and

MARR, Simple and compound interest rates

2. Various Type of Factors

These were three

Factors Single payment Factors “Foundational

P/F, F/P Pillars” we need

Uniform Series Factors

P/A, A/P, F/A, A/F for using “various

Gradient Series Factors engineering

Arithmetic Gradient and Geometric Gradient economy criteria”

for decision

3. Dealing with Shifted Series making

Shifted uniform series

Shifted series and single cash flows

Shifted gradients

2/15/2016

foundational pillar” before

studying formal engineering

economy EVAUALTING criteria

of decision making

Chapter 4

Nominal and Effective

Interest Rates

2/15/2016

• Interest Rate: important terminologies

• Nominal and Effective Rate of Interest

• Effective Annual Interest Rate

• Converting Nominal rate into Effective Rate

• Calculating Effective Interest rates

• Equivalence Relations: PP and CP

• Continuous Compounding

• Varying Interest Rates

Simple Example

2/15/2016

Compounded daily

How much Paid $1000 from credit card

after a year is really

you going to $1150 ? Lets do

1000+150 = $1150 ?

pay after 1 check!!!

year ?

Rate is 15% per year but compounding is daily … so the rate at per day is 0.15/365 =

0.000411 per day or 0.0411% per day

Days Amount ($) Interest earned Total due ($) 1161.815863 …..

But this is around

1 1000 Amount x r =0.411 1000.411

16.81% rate … rather

2 1000.411 0.411169 1000. 82269 than 15% stated

- -------- ------ ------ next slide

for each period

But interest “due” is

1161.815863 …. But this is increasing in every

around 16.81% rate … rather period

than 15% stated

• denoted by (r) • Denoted by (i)

• does not include any consideration of • take accounts of the effect of the

the compounding of compounding period

interest(frequency) • commonly express on an annual

• It is given as: r = interest rate per basis (however any time maybe

period x number of compounding used)

periods

2/15/2016

Previous Learning

• Our learning so for is based “one” interest rate that’s

compounded annually

commonly based upon interest rates compounded more

frequently than annually

distinction need to be made between nominal and

effective rate of interests

Interest Rate:

important terminologies

Interest period (t) – period of time over which interest is expressed.

For example, 1% per month.

Compounding period (CP) – The time unit over which interest is charged or earned.

For example,10% per year, here CP is a year.

interest period t.

For example, at i = 10% per year, compounded monthly, interest would be

compounded 12 times during the one year interest period.

2/15/2016

Statements

interest period (t) = 1 year

compounding period (CP) = 1 month

compounding frequency (m) = 12

interest period (t) = 1 year

compounding period (CP) = 1 Week

compounding frequency (m) = 52

IMPORTANT: Compounding

Period and Interest Rate

Interest statement

………..It means that interest is compounded each

month; i.e., Compounding Period is 1 month.

mentioned it is understood to be the same as the time

period mentioned with the interest rate.

2/15/2016

Calculating Effective

Interest Rate

period can be calculated as follows:

Example:

generation equipment are listed below.

Determine the effective rate on the basis of the

compounding period for each rate

(a) 9% per year, compounded quarterly

(b) 9% per year, compounded monthly

(c) 4.5% per 6 months, compounded weekly

2/15/2016

Example: Calculating

Effective Interest rates per CP

a. 9% per year, compounded quarterly.

b. 9% per year, compounded monthly.

c. 4.5% per 6 months, compounded weekly.

Class Practice 1:

calculate the effective interest rate

i. If compounding period is yearly 18%

ii. If compounding period is semi-annually 9%

iv. If compounding period is monthly 1.5%

v. If compounding period is weekly 0.346%

vi. If compounding period is daily 0.0493 %

2/15/2016

Rates

• When we talk about “Annual” we consider year as the

interest period t , and the compounding period CP can be

any time unit less than 1 year

• Nominal rates are converted into Effective Annual Interest Rates (EAIR)

via the equation:

= (1 + ) −1 = (1 + ) −1

ia = effective annual interest rate time period

i = effective rate for one compounding period (r/m)

m = number times interest is compounded per year

compounded CP-ly

2/15/2016

Example

For a nominal interest rate of 12% per year, determine the nominal and effective

rates per year for

(a) quarterly, and ia = (1 + i)m – 1

(b) monthly compounding

where ia = effective annual interest rate

i = effective rate for one compounding

Solution: period (r/m)

m = number times interest is compounded

per year

(a) Nominal r per year = 12% per year

Nominal r per quarter = 12/4 = 3.0% per quarter

Effective i per year = (1 + 0.03)4 – 1 = 12.55% per year

(b) Nominal r per month = 12/12 = 1.0% per month

Effective I per year = (1 + 0.01)12 – 1 = 12.68% per year

15% per year

Compounded daily

Economic Equivalence:

From Chapter 1

in economic value at a given rate

$110

Rate of return = 10% per year

Year

0 1

1

$100 now

now, if the $100 is invested at a rate of 10% per year

Economic Equivalence: Combination of interest rate (rate of return) and

time value of money to determine different amounts of money at different

points in time that are economically equivalent …..

Compounding/Discounting (F/P, P/F, F/A, P/G etc.)

2/15/2016

Period(PP) & Compounding

Period(CP)

between cash flows (inflows or outflows)

• Assume the monthly payments as shown below

CP CP

6 months 6 months

0 1 2 3 4 5 6 7 8 9 10 11 12 Months

│PP │

1 month PP = CP, PP >CP, or PP<CP

Period(PP) and Compounding Period

compounding period (CP) do not coincide

…Interest rate must coincide with compounding period

Length of Time Involves Single Involves Gradient

Amount Series (A, G, or g)

(P and F Only)

PP = CP P/A, P/G, P/g

P/F , F/P

PP > CP F/A etc.

PP < CP P/F, F/P P/A, P/G, F/A etc.

2/15/2016

Thank You

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