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

2. Average inflation rate (f)
Step 1 - simple compounding
$100( )( ) = $112.32
Step 2 - equiv eqn
$100(1 + f)2 = $112.32
solve for f

3. 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

4. Example 11.2

5. 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

6. Example 11.3

7. Figure 11.1

8. Conversion from Actual to Constant Dollars
(11.5)
example 11.4

9. 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)

10. Constant Dollar Analysis
Example 11.5

11. Actual Dollar Analysis
Deflation method
copy page 573

12. Actual Dollar Analysis cont
Adjusted discount method
example 11.7
figure 11.3

13. Mixed Dollar Analysis
Page 577 and 578

14. Effects of Inflation on Project Cash Flows
Depreciation Expenses under Inflation
page 581

15. Multiple Inflation Rates
Table 11.3

16. Multiple Inflation Rates
Solution on page 583

17. Effects of Borrowed Funds under Inflation
Solution on page 584

18. Effects of Borrowed Funds under Inflation
Page 585

19. Rate of Return Analysis Under Inflation
Table 11.5

20. 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%

21. Rate of Return Analysis Under Inflation
put table 11.5 and 11.6 on the same page next to each other (shrink if necessary)

22. Effect of Inflation on Working Capital
Figure 11.6

23. Table 11.7

24. IEN255 Summer’99 Chapter 10,11,13 HW#4
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)