466 INFLATION AND PRICECHANGE14-5 What is the Consumer Price Index (CPI)? What is the
difference between commodity specific and compo-
site price indexes? Can each be used in engineering
economic analysis?
14-6 In Chapters 5 (Present Worth Analysis) and 6
(Annual Cash Flow Analysis) it is assumed that prices
are stable and a machine purchased today for $5000
can be replaced for the same amount many years
hence. In fact, prices have generally been rising, so
the stable price assumption tends to be incorrect.
Under what circumstances is it appropriate to use the
"stable price" assumption when prices actually are
changing?
14-7 An economist has predicted that there will be a 7%
per year inflation of prices during the next 10 years.
If this proves to be correct, how much will an item
that presently sells for $10 bring a decade hence?
(Answer: $19.67)
14-8 A man bought a 5% tax-free municipal bond. It cost
$1000 and will pay $50 interest each year for 20 years.
The bond will mature at the end of the 20 years
and return the original $1000. If there is 2% annual
inflation during this period, what rate of return will
the investor receive after the effect of inflation has
been accounted for?
14-9 A man wishes to set aside some money for his daugh-
ter's college education. His goal is to have a bank
savings account containing an amount equivalent to
$20,000 with today's purchasing power of the dollar,
at the girl's 18th birthday. The estimated inflation rate
is 8%. If the bank pays 5% compounded annually,
what lump sum of money should he deposit in the
bank savings account on the child's 4th birthday?
(Answer: $29,670)..14-10 An economist has predicted that for the next 5 years,
the United States will have an 8% annual inflation
rate, followed by 5 years at a 6% inflation rate. This
is equivalent to what average price change per year
for the entire 1O-year period?
14-11 A newspaper reports that in the last 5 years, prices
have increased a total of 50%. This is equivalent
to what annual inflation rate, compounded annually?
(Answer:8.45%)
14-12 A South American country has had a high rate of in-
flation. Recently, its exchange rate was 15 cruzados
per dollar; that is, one dollar will buy 15 cruzados
in the foreign exchange market. It is likely that the
country will continue to experience a 25% inflation
rate and that the United States will continue at a 7%
inflation rate. Assume that the exchange rate will vary
the same as the inflation. In this situation, one dollar
will buy how many cruzados 5 years from now?
(Answer: 32.6)
14-13 An automobile manufacturer has an automobile that
gets 10 kilometers per liter of gasoline. It is estimated
that gasoline prices will increase at a 12% per year
rate, compounded annually, for the next 8 years. This
manufacturer believes that the automobile fuel con-
sumption for its new automobiles should decline as
fuel prices increase, so that the fuel cost will remain
constant. To achieve this~ what must be the fuel rat-
ing, in kilometers per liter, of the automobiles 8 years
hence?
14-14 An economist has predicted that during the next
6 years, prices in the United States will increase 55%.
He expects a further increase of25% in the subsequent
4 years, so that prices at the end of 10 years will have
increased to 180% of the present level. Compute the
inflation rate,f, for the entire 10-year period.
14-15 Sally Johnson loaned a friend $10,000 at 15% inter-
est, compounded annually. She is to repay the loan
.in five equal end-of-year payments. Sally estimates
the inflation rate during this period is 12%. After tak-
ing inflation into account, what rate of return is Sally
receiving on the loan? Compute your answer to the
nearest 0.1%. (Answer: 2.7%)
14-16 Dale saw that the campus bookstore is having a special
on pads of computation paper normally priced at $3 a
pad, now on sale for $2.50 a pad. This sale is unusual
and Dale assumes the paper will not be put on sale
again. On the other hand, Dale expects that there will
be no increase in the $3 regular price, even though the
inflation rate is 2% every 3 months. Dale believes that
competition in the paper industry will keep wholesale
and retail prices constant. He uses a pad of computa-
tion paper every 3 months. Dale considers 19.25% a
suitable minimum attractive rate of return. Dale will
buy one pad of paper for his immediate needs. How
many extra pads of computation paper should he buy?
(Answer: 4)
14-17 An investor wants a real rate of return if(rate of
return without inflation) of 10% per year on any
projects in which he invests. If the expected annual
inflation rate for the next several years is 6%, what
interest rate i should be used in project analysis
calculations?