Engineering Economic Analysis

Meaning and Effect of Inflation 445

Since6.0% is the inflation rate(I) and 8.0% is the market interest rate(i),we can write

if= (0.08 - 0.06)/0+ 0.06)= 0.01887, or 1.887%

Therefore, $1,200,000 was the cost of the building in 1950. These were the actual. dollars(A.$)

spent in 1950.

FromFigure 14-1wearegoingfromactualclollarsat t, in )950,toactualdollarsat n, in 2005.

To do so, we use themarket interest fateandcompQuridthis amountfo:rWardiIlnm~55years, as

illustrated in Figure 14-2.

Actual dpllars in 2005=Actual doUars.in.1950(FI P, i,55 years)

= $1,200,000(FIP~8%,55)

. $82,701,600

FIGtJ~14-2 DiscountingA$ in 1950 toA$

in 2005.

$82,701,600

I

I

I

I

$1,200,000

t

195,9

8%.

2005

Nowwe"want to detefITIinethe amountofrealdollars'--.basedinl;95rJ.=that(Jccurin theyear

2005, wnich are equivalent to the$82.7nll1li~n ft(jrn the solutiQp. to partb; tetl.ls'S()rV~ .tJjis

problern;hvo ways.

1.. trtthis approachletusdirectly'tJ;anslatethe actualilollars in the yegr 2005 to re.al,)950"

based dollars in the.year2005..FrornJ3igutel4-1 w~can'hse.tlJ,~i1J,fl~ti()I11"9teto.sn-ip

55 years of inflation from the actual. d6I1ars.We .dotlJiS byusip.gtlJ,eP{f faC.!9t;fo(

55.years at tlJ,einflation rat~.We arep.()tPbysic~llYI~lpvingtlJ,e.dQll(lf~i1J,tim~in tljiscase;

rltherwe are siInplyremovinginflatioufromthese dollars one' !~(lfata tft!Je"'tl},ecf1lf

~1ctordoes thatfor us. Tltis.isillustratedip. tJ:iefOllowing eqpatiop,and,Ifigur~14-J;

II

~ J~'..x~!<i.-5.P~1:t~~d:.4oUars~mc.2QQ.$-,"..~(~~tp.Al,,-dPU~~-'f~Q.Q.~}Q~Ul,ik~5~):;:;:: ~

.($82,701,600)(P iF,.. .. ,. 6%, 5~)"

.$3,357,000

II

\I

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