Engineering Economic Analysis

Different Inflation Ratesper Period 459

EUAC - [19,102(PI F,20%, 1) + 20,349(P I F,20%, 2) +20,238(P I F,70%, 3)

+ 20,197(P IF, 20%, 4) +20,171(P IF, 20%,5)](Alf,20%, 5)

--1$19,900 per year

In Example 14-7,both today's cost for each vegetable and the respectiveinflation rates

were used to calculate the yearly costs of purchasing the desired quantitiesover the 5-year

period. As in Example 14-6, we obtained a total marginal cost (in terms of actual dollars)

by combining the two individual yearly costs. We then calculated the equivalentuniform

annual cost (EUAC) using the given market interest rate.

Example 14-8 provides another example of how the effect of changes in inflation rates

over time can affect an analysis.

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If general price inflation is estimated to be 5% for the next 5 years, 7.5% for the 3 years after

that, and 3% the following 5 years, at what market interest rate(i)would you have to invest your

money to maintain a real purchasing power growth rate(i')of 10% during those years?

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ill Years1-5 Youmustinvestat 0.10 + 0.050+ (0.10)(0.050)=0.1150=11.50%per year.

In Years 6-8 you must invest at 0.10 + 0.075 + (9.10)(0.075)=0.1825=18.25% per year.

In Years9-13 yoUmust invest at 0.10 + 0.030 + (0.10)(0.030)- 0.1330== 13.30% per year.

(Note:This,exarqple illustrates a common problem in timing: the market interest rate necessary
to maintain the real purchasing power of the investment must be calculated at a time when the
-inflation rate is Qnly an estimate. Most interest-bearing investments have fixed, up-front rates

Ithat the investorwell understandsgoing jnto the investment.Variable.rateinvestmentsat"ethe
lexception. On the!other hand, inflation is not quantified, and its effect on our real return is n2t
~mea'sured;ffiitil1hwe1fd1>fthefear5T~eI&e~10 acliiev~ilieconOitibns~reqiiire=a1nfue erampie, --

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one would either ijave to anticipate inflation and adjust one's investments accordingly, or accept

the !<;lct~hat theJe~ investment return(i')mar not tupI;;out to be wh~t w~ origjnalty r~9.uiredJ

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Year , Lima Beans Corn Total

(^0) $5,460 $12,480
(^1) 5,460(1.03)=5,624 12,480(1.08) = 13,478 $19,102
(^2) 5,624(1.03) = 5,793 13,478(1.08) = J4,556- 20,349
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(^3) 5,793(1.03) = 5,967 14,556(1.02)-1 = 14,271 20,238
(^4) 5,967(1.04) = 6,206 14,271(1.02)'-1=13,991 20,197
(^5) 6,206(1.04) = 6,454 13,991(1.02)-1 = 13,717 20,171