IEN255 Chapter 11 - Inflation

1
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

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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

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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 An constant dollar expression for the
  cash flow
• where An actual dollar expression for the cash
  flow

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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

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Equivalence calculations under inflation

• Two Types
• Market 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) -30,00012,700(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) -30,00012,336(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

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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
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IEN255 Summer99 Chapter 10,11,13 HW4

• Homework Assignment
• Chapter 10
• s 10.4 10.6 10.24
• Chapter 11
• s 11.1 11.6 11.13
• Chapter 13
• s 13.9
• Due together (Tues July 27)