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Geometric Gradient Series in Economics

The document discusses the present equivalent of a geometric gradient series and how to compute equivalent uniform series or future amounts using basic interest factors. It includes an example of calculating present (P), annual (A), and future (F) equivalent values for a cash flow sequence with a specified rate of increase and interest rate. Additional information on geometric sequences of cash flows is referenced for further reading in Chapter 8.

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11 views1 page

Geometric Gradient Series in Economics

The document discusses the present equivalent of a geometric gradient series and how to compute equivalent uniform series or future amounts using basic interest factors. It includes an example of calculating present (P), annual (A), and future (F) equivalent values for a cash flow sequence with a specified rate of increase and interest rate. Additional information on geometric sequences of cash flows is referenced for further reading in Chapter 8.

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aelhammamiigcse
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© All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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150 CHAPTER 4 / THE TIME VALUE OF MONEY

brackets reduces to N, the number of terms in the summation. Hence,


!
A1 (1 + i)−1 (1 − xN )/(1 − x) f̄ ̸ = i
P=
A1 N(1 + i)−1 f̄ = i,
which reduces to
⎧ −N N
⎨ A1 [1 − (1 + i) (1 + f̄ ) ]
⎪
f̄ ̸ = i
P= i − f̄ (4-29)
⎪
⎩
A1 N(1 + i)−1 f̄ = i,
or
⎧ ∗
⎨ A1 [1 − (P/F, i%, N)(F/P, f̄ %, N)]
⎪
f̄ ̸= i
P= i − f̄ (4-30)
⎪
⎩
A1 N(P/F, i%, 1) f̄ = i.

Once we know the present equivalent of a geometric gradient series, we can


easily compute the equivalent uniform series or future amount using the basic
interest factors (A/P, i%, N) and (F/P, i%, N).
Additional discussion of geometric sequences of cash flows is provided in
Chapter 8, which deals with price changes and exchange rates.

Equivalence Calculations for an Increasing Geometric


EXAMPLE 4-23
Gradient Series
Consider the following EOY geometric sequence of cash flows and determine
the P, A, and F equivalent values. The rate of increase is 20% per year after the
first year, and the interest rate is 25% per year.

Solution

$1,000(1.2)3

$1,000(1.2)2
$1,000(1.2)1
$1,000

0 1 2 3 4
End of Year
& '
$1,000 1 − (P/F, 25%, 4)(F/P, 20%, 4)
P=
0.25 − 0.20

∗ Equation (4-30) for f̄ ̸ = i is mathematically equivalent to the following:


( )
A1 1+i
P= P/A, − 1, N .
(1 + f̄ ) 1 + f̄

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