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ME 291 Engineering Economy

This document summarizes key concepts about the impact of inflation from Chapter 14 of the textbook Engineering Economy. It defines inflation and deflation, provides formulas for converting between dollars in different time periods adjusting for inflation, and distinguishes between real and inflation-adjusted interest rates. It also gives examples of present worth calculations both with and without adjusting for inflation.

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100 views

ME 291 Engineering Economy

This document summarizes key concepts about the impact of inflation from Chapter 14 of the textbook Engineering Economy. It defines inflation and deflation, provides formulas for converting between dollars in different time periods adjusting for inflation, and distinguishes between real and inflation-adjusted interest rates. It also gives examples of present worth calculations both with and without adjusting for inflation.

Uploaded by

salmanshahidkhan
Copyright
© Attribution Non-Commercial (BY-NC)
Available Formats
Download as PPT, PDF, TXT or read online on Scribd
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ME 291

Engineering Economy
Lecture 25
Effect of Inflation – Chapter 14

Faculty of Mechanical Engineering


Ghulam Ishaq Khan Institute, Topi, Swabi

ENGINEERING
ECONOMY
Impact of Inflation

• Inflation is an increase in the amount of


money necessary to obtain the same
amount of product or service before the
inflated price was present.
• Deflation is the opposite of inflation.

ENGINEERING
ECONOMY
Formulae
• Money in one period of time t1 can be brought to the same
value as money in another period of time t2 by using the
equation.

• Dollars in period t1 are called constant-value dollars or


today’s dollars. Dollars in period t2 are called future dollars.
If f represents the inflation rate per period (year) and n is
the number of time periods (years) between t1 and t2, then

ENGINEERING
ECONOMY
Types of Interest Rates

• Real or inflation-free interest rate I


when there is no inflation involved
• Inflation-adjusted interest rate if
interest rate in which inflation has been taken into account.
Also called inflated interest rate.

ENGINEERING
ECONOMY
PW calculations adjusted for inflation

• When the dollar amounts in different periods are


expressed in constant value dollars, the equivalent
present and future amounts are determined using the
real interest rate i.
• For example $5000 with an inflation rate of 4% will
become 5000(1.04)4 = 5849 after 4 years. But if the
constant value of these dollars is found out at that time
by 5849/(1.04)4 = 5000 then the present worth can be
found by applying simple interest rate.
• If the value is not converted to constant value dollars
then the present worth calculation has got a modified
formulae.

ENGINEERING
ECONOMY
PW calculation (Contd….)
• We know that

• With inflation rate f involved the formulae can be modified to

or

Where if = i + f + if

ENGINEERING
ECONOMY
Example 14.1

ENGINEERING
ECONOMY
Example 14.2
• A 15-year $50,000 bond has a dividend rate of 10% per
year, payable semiannually, is currently for sale. If the
expected rate of return of the purchaser is 8% per year,
compounded semiannually, and if the inflation rate is
expected to be 2.5% each of 6-month period, what is the
bond worth now (a) without an adjustment for inflation
and (b) when inflation is considered?

ENGINEERING
ECONOMY
Example 14.3
• A self-employed chemical engineer is on
contract with Dow Chemical, currently working
in a relatively high-inflation country. He wishes
to calculate a project’s PW with estimated cost
of $35,000 now and $7000 per year for 5 years
beginning 1 year from now with increase of
12% per year thereafter for the next 8 years.
Use a real interest rate of 15% per year to
make the calculations (a) without an
adjustment for inflation and (b) considering
inflation at a rate of 11% per year.

ENGINEERING
ECONOMY

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