Appendix A 251Year 1: $1000.00
Year 2: $1000.00
Year 3: $1000.00
Year 4: $1000.00
The key to proper economic analysis under inflation is to base the
value of MARR on the types of cash flows. If the cash flows contain in-
flation, then the value of MARR should also be adjusted for inflation.
Alternatively, if the cash flows do not contain inflation, then the value of
MARR should be inflation-free. When MARR does not contain an adjust-
ment for inflation, it is referred to as a real value for MARR. If it contains
an inflation adjustment, it is referred to as a combined value for MARR.
The relationship between inflation rate, the real value of MARR, and the
combined value of MARR is given by:
1 + MARRCOMBINED
= (1 + inflation rate) * (1 + MARRREAL)
Example 28
If the inflation rate is 3%/yr and the real value of MARR is 15%/yr, what
is the combined value of MARR?
1 + MARRCOMBINED
= (1 + inflation rate) * (1 + MARRREAL)
1 + MARRCOMBINED = (1 + 0.03) * (1 + 0.15)
1 + MARRCOMBINED = (1.03) * (1.15)
1 + MARRCOMBINED = 1.1845
MARRCOMBINED = 1.1845 – 1 = 0.1845 = 18.45%If the cash flows of a project are stated in terms of then-current dol-
lars, the appropriate value of MARR is the combined value of MARR.
Analysis done in this way is referred to as then current analysis. If the
cash flows of a project are stated in terms of constant-worth dollars, the
appropriate value of MARR is the real value of MARR. Analysis done in
this way is referred to as then constant worth analysis.