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Engineering Economy
IEN255 Chapter 11 - Inflation
Inflation vs Deflation
Inflation - a loss in purchasing power of money over time
Deflation - prices decrease of time
Measuring inflation - Consumer Price Index (CPI)
Survey of Current Business - for industrial products
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Average inflation rate (f)
Step 1 - simple compounding $100(1 + 0.04)(1 + 0.08) = $112.32
Step 2 - equiv eqn $100(1 + f)2 = $112.32 solve for f
Engineering Economy
General inflation rate vs Specific
General Inflation Rate ( ) - average inflation rate calculated based on the CPI
Specific Inflation Rate (fj) - inflation rate calculated based on a specific segment j of the economy.(if just one item, drop the subscript j)
equations 11.1 and 11.2 with defs
f
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Example 11.2
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Actual vs Constant Dollars
Actual (current) dollars - estimates of future cash flows for year n that take into account any anticipated changed in amount due to inflation
Constant (real) dollars - constant purchasing power independent of time (adjusted using an accepted general inflation rate)
To convert use 11.4 where A’n = constant dollar expression for the cash
flow where An = actual dollar expression for the cash
flow
),,/(')1(' nfPFAfAA nn
nn
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Example 11.3
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Figure 11.1
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Conversion from Actual to Constant Dollars
(11.5)
example 11.4
),,/()1(
'' nfFPA
f
AA nn
nn
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Equivalence calculations under inflation
Two TypesMarket Interest Rate (i) (typically inflation-
adjusted MARR)Inflation-free Interest Rate (i’)- real interest
rate (prev chaps)
Case 1: All in constant dollars Case 2: All in actual dollars Case 3: Mix (convert all to either case 1 or 2)
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Constant Dollar Analysis
Example 11.5
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Actual Dollar Analysis
Deflation method
copy page 573
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Actual Dollar Analysis cont
Adjusted discount method
example 11.7
figure 11.3
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Mixed Dollar Analysis
Page 577 and 578
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Effects of Inflation on Project Cash Flows
Depreciation Expenses under Inflation
page 581
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Multiple Inflation Rates
Table 11.3
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Multiple Inflation Rates
Solution on page 583
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Effects of Borrowed Funds under Inflation
Solution on page 584
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Effects of Borrowed Funds under Inflation
Page 585
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Rate of Return Analysis Under Inflation
Table 11.5
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Rate of Return Analysis Under Inflation
RoR without inflation PW(i’) = -30,000+12,700(P/F,i’,1) + 14,033
(P/F,i’,2)+ 10,478 (P/F,i’,3) + 9,589 (P/F,i’,4)
Solve for IRR’ = i’* = 21.88%
RoR under inflation PW(i’) = -30,000+12,336(P/F,i’,1) + 13,108
(P/F,i’,2)+ 10,036 (P/F,i’,3) + 9,307 (P/F,i’,4)
Solve for IRR’ = i’* = 19.40%
Engineering Economy
Rate of Return Analysis Under Inflation
put table 11.5 and 11.6 on the same page next to each other (shrink if necessary)
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Effect of Inflation on Working Capital
Figure 11.6
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Table 11.7
Engineering Economy
IEN255 Summer’99 Chapter 10,11,13 HW#4
Homework Assignment:Chapter 10#’s 10.4; 10.6; 10.24Chapter 11#’s 11.1; 11.6; 11.13Chapter 13#’s 13.9
Due together (Tues July 27)