CASH FLOW ANALYSIS

Non Uniform Annuities, Perpetuities

and Case Study
 Administrative Items
Online Quiz 1:
o Started, Friday May 19 at 11:00 PM
o Ends tonight, Friday May 26 at 11:59 PM
o Chapters 1, 2 and up to annuities in Chapter 3 (not including mortgages, bonds
and non-uniform annuities).
o Chapters 1, 2 & 3 including general concept of EE, decision making, time
value of money, interest rate calculations, cash flow diagram, and annuities.

Online Quiz 2:
o Starts tonight, Friday May 26 at 11:00 PM
o Ends, Friday June 2 at 11:59 PM
o Chapters 3
o Chapter 3 including non-uniform annuities, bonds and mortgages; there
will also be a small number of 'review-type' questions from Chapter 2.

2
 Learning Objectives

Arithmetic gradient annuity series

Geometric gradient annuity series
Capitalized value formula for perpetuities
Compound interest factors summary

3
 Arithmetic Gradient

A uniformly increasing series:

o Consists of two components:
o Series component (A)
o Gradient component (G)

Therefore:
o P = A(P/A, i%, n) + G(P/G, i%, n)

4
 Arithmetic Gradient, contd.
arithmetic gradient present worth factor:

1 + 1
, , =
2 1 +

arithmetic gradient uniform series factor:

1
, , =
1+ 1

5
Arithmetic Gradient, contd.

6
Arithmetic Gradient, contd.

7
Arithmetic Gradient, contd.

8
 Arithmetic Gradient, contd.
Problem 1
A lottery prize pays $1000 at the end of the first year, $2000 the second,
$3000 the third, etc., for 20 years. If there is only one prize in the lottery, 10
000 tickets are sold, and you can invest your money elsewhere at 15%
interest, how much is each ticket worth, on average?

Solution
Method 1: First find annuity value of prize and then find present value of
annuity.

9
 Arithmetic Gradient, contd.
Problem 1
A lottery prize pays $1000 at the end of the first year, $2000 the second,
$3000 the third, etc., for 20 years. If there is only one prize in the lottery, 10
000 tickets are sold, and you can invest your money elsewhere at 15%
interest, how much is each ticket worth, on average?

Solution
Method 2: Find P1 with A' = 0, G = 1000 and N = 21. Then find P0.

10
Reality and the Assumed Uniformity
of A, G, and g
Although the future reality may not exactly follow the
uniformity of our series and gradient equations, we may
use these formulas because:
1. It is easier to start with simple models
2. Convenient for modelling the future with approximate
constraints and bounds
3. Not enough is known about the future and so it is
approximated through uniform series and gradients

11
 Geometric Gradient

Period-by-period change is at a uniform rate (g)

Expressed as a percentage

12
 Geometric Gradient, contd.
A series of cash flows that increase or decrease by a
constant proportion each period
Cash flows A, A(1 + g), A(1 + g)2,A(1 + g)N1 are at the
end of periods 1, 2, 3, ..., N respectively
g is growth rate, positive/negative percentage change
Can model inflation/deflation using geometric series
Geometric Gradient to PW Conversion:(P/A, g, i, N)

13
 Geometric Gradient, contd.
need
need what
what is is called
called a a growth
growth adjusted
adjusted interestinterest rate:
rate:
1
1
ii 1
1 1
1
g
g
ii
1 so that
1 i
1 so that
1
1 gg 1
1 ii 1 i
used
used as
as follows:
follows: (P / A, g, i , N ) ((1 1
N
ii ))N 1
1 1 1
(P / A, g, i , N ) g
ii ((1
1 i )
i
)N
N 1
1 g


,N)
(P/A,i
(P/A,i ,N)


1
(( 1 g)
g)
1. i > g > 0: i is positive use tables or formula
2. g < 0: i is positive use tables or formula
3. g > i > 0: i is negative must use formula
i = positive P A
A
4. g = i > 0:
P N
N
1
1 g
g
14
 Geometric Gradient, contd.

Two possible cases:

o Where: i g
1 1 + (1 + )
= 1

o Where: i = g
= 1 (1 + )1

o Factor Notation: (P/A, g, i, n)

15
 Geometric Gradient, contd.
Problem 2
Suppose that the salary of an engineer during the coming year is expected to be $128 000. It is
expected to increase by 12% per year over the following four years, when she would retire and
receive a pension. She has just been in a bad accident and will be unable to work again, so a judge is
estimating the lump sum amount that the insurance company must pay to the engineer now in order
to replace her salary. The interest rate is taken to be 10%, compounded yearly, during this period.
What is the present worth now of the earnings over the next five years?

16
 Geometric Gradient, contd.
Problem 3

A = [800 + 20(A/G,6%,7)]x(P/A,6%,7)(A/P,6%,10) + [300(F/A,6%,3) - 500]x(A/F,6%,10)

17
 Present Worth Perpetuities (N)

model is reasonable for long-lived projects

P in this case called the capitalized value
The capitalized value formula is: P = A/i

(1 i )N 1
P lim A(P / A, i , N ) A lim
N N i (1 i )N

A

i

18
 Present Worth Perpetuities (N)
Problem 4
A $500 000 gift was bequeathed to a city for the construction and continued
maintenance of a small music hall. Annual maintenance for a hall is estimated at
$15 000.
In addition, $25 000 will be needed every 10 years for painting and major
repairs.
How much will be left for the initial construction costs after funds are allocated
for perpetual upkeep? Interest is 6% per annum.

19
Compound Interest Factors Summary

Timing of Cash Flows and Modeling

Compound Interest Factors
o Single Receipts or Disbursements
o Annuities
o Arithmetic Gradient Series
o Geometric Series
Present Worth Computations when N
o Capitalized Value Formula for Perpetuities

20
Compound Interest Factors Summary

21
Questions Period

22