Chapter 4 Equivalence Calculations under Inflation

4.1) Average Price index = ($5.20$2.10)/$2.10 = 1.476 = 147.6% Ans.

4.2) Average Inflation rate

3.5 = 0.8(1 + f )16
1
3.5
16
f = - 1 = 9.66% Ans.
0.8

4.3)
1/10
185.1
(a ) f = - 1 = 1.16%
164.5

( )
8
= 164.5 ( 1 + 0.0116 ) = 180.39
8
CPI 2009 = CPI 2001 1 + f

(1+ f ) = 164.5 ( 1 + 0.0116 ) = 191.10

13 13
(b) CPI 2014 = CPI 2001

( 1 + 0.06 ) ( 1 + 0.10 ) - 1 = 0.166 = 16.6%

4.4)

4.5)
1
638, 400
f1 = - 1 = 2.3%
624, 000
1
677, 000
f2 = - 1 = 6.04%
638, 400
1
729,500
f3 = - 1 = 7.75%
677, 000
1/3
729,500
f = - 1 = 5.34%
624, 000

4.6)
log 3
n= = 14.27 Years Ans.
log1.08
Fundamentals of Engineering Economics, 3rd ed. 2012

1/8
75, 000
f = - 1 = 8.17% Ans.
4.7) 40, 000

4.8)
1/27
205.43
f = - 1 = 6.56%
36.87
Re al salary = 48, 000(1 + 0.0656) -27 = $8633.71Ans.

4.9)
i = i
+ f + i
f
i - f 0.09 - 0.05
=
i = = 3.8%
1+ f 1 + 0.05
Investment is not suggested .

4.10)
12
0.04
ia = 1+ - 1 = 4.074%
12
i - f 0.0407 - 0.05
i = = = -0.00857
1+ f 1 + 0.05
Loss = $12000 -0.00857 = -$106.28 Ans.

4.11)
i = i ' + f + i ' f = 0.07 + 0.04 + 0.07 0.04 = 0.1128 = 11.28%

4.12)
i - f 0.16 - 0.1
=
i = = 5.45%
1+ f 1 + 0.1
P = 20, 000 + 26, 000 + 34, 000 + 38, 000 + 42, 000 = A( P / A,5.45%,5)
0.0545 (1 + 0.0545)5
A = 160, 000 = $37, 416.87 Ans.
(1 + 0.0545) - 1
5

Given: i = 16%, f = 4%
4.13)

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Fundamentals of Engineering Economics, 3rd ed. 2012

n Actual dollars Constant Dollars

0 $20,500
4 $41,500
5 $36,500
4.14)
7 $55,500
$20,500(P/F,4%,0) = $20,500
$41,500(P/F,4%,4) = $35,474.37
$36,500(P/F,4%,5) =$30,000.34
$55,500(P/F,4%,7) = $42,175.44

0.1/12 - 0.06 / 12
monthly =
i = 0.00331
1 + 0.06 /12

( 1 + 0.0033) - 1
48

15, 000 = A 48
= $338.41( ActualValue)Ans.
0.0033 ( 1 + 0.0033)
15
1
P = 338.41 = $322.09 (Cons tan tValue) Ans.
1 + 0.0033

i - f 0.16 - 0.1
=
i = = 5.45%
4.15) 1+ f 1 + 0.1

EO Constant Value Actual Value

Y
0 50,000
1 50,000 1.08 =54,000
2
2 50,000 1.08 =58,320
3 50,000 1.083 =62,985.6
50,000
50,000 1.054 =52,700
50,000 1.0542 =55,545.8
50,000 1.0543 =58,545.27

PW on constant dollar analysis

2 3
1 1 1
PW = 50, 000 + 54, 000 + 58,320 + 62,985.6 = $207,522.83 Ans.
1 + 0.054
1 + 0.054
1 + 0.054

PW on Actual dollar analysis
2 3
1 1 1
PW = 50, 000 + 52, 700 + 55,545.8 + 58,545.27 = $199,999.99 Ans.
1 + 0.054
1 + 0.054
1 + 0.054

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Fundamentals of Engineering Economics, 3rd ed. 2012

4.16)

EOY Payment Actual Dollar Constant Dollar

each year
0 1500 1500 1500
1 1500 1500 1.085 = 1627.5 1627.5/1.04 = 1564.9
2 1500 1500 1.085 =1765.83 1765.83/1.042 =1504.71
2

4.17)
14th int erest payment = $2000 0.04 = $80.0
The14th int erest payment (7th year ) in cons tan t dollar :
I14= $80( P / F ,5%, 7) = 80 0.6651 = $53.20 Ans.

4.18)
31.90(1 + f )6 = 41
f = 4.27%

Year Net Cash Flow Conversion Net Cash Flow

in Actual $ factor in Constant $
2004 31.90 (1 + 0.0427)0 31.90
-1
2005 33.40 (1 + 0.0427) 32.03
-2
2006 33.80 (1 + 0.0427) 31.09
-3
2007 36.30 (1 + 0.0427) 32.02
2008 36.50 (1 + 0.0427)-4 30.88
-5
2009 38.00 (1 + 0.0427) 30.83
-6
2010 41.00 (1 + 0.0427) 31.90

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Fundamentals of Engineering Economics, 3rd ed. 2012

4.19)

(a) Pr esentValue in absence of inf letion :

( 1 + 0.045 ) - 1
10 5
1
PW = A( P / A, 4.5%,10) + F ( P / F ,9%,5) = 150 10
+ 2000
0.045 ( 1 + 0.045 )
1 + 0.09

= $2487.51Ans.
i - f 0.09 - 0.04
(b) =
i = = 0.048 = 4.8%
1+ f 1 + 0.04

( 1 + 0.024 ) - 1
10 5
1
PW = A( P / A, 2.4%,10) + F ( P / F , 4.8%,5) = 150 10
+ 2000
0.024 ( 1 + 0.024 ) 1 + 0.048

= $2902.35Ans.
4.20)
i = i ' + f + i ' f = 0.03 + 0.05 + 0.03 0.05 = 0.0815 = 8.15%
5
1
PW of fifth payment = 80000 = $54070.12 Ans.
1 + 0.0815

4.21)
i - f 0.0075 - 0.0025
=
i = = 0.00498 = 6.86%
1+ f 1.0025
60, 000 0.00498 1.0049860
A= = $1159.29 Ans.
1.0049860 - 1

4.22)

i = i ' + f + i ' f = 0.07 + 0.04 + 0.07 0.04 = 0.1128 = 11.28%

( 1 + 0.1128 ) - 1
5

PW of Fuel cos t = A( P / A,11.28%, 5) = 1.8 5
= $6.606 Million Ans.
0.1128 ( 1 + 0.1128 )

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Fundamentals of Engineering Economics, 3rd ed. 2012

4.23)
i - f 0.08 - 0.01
(a ) =
i = = 0.0693 = 6.93% Ans.
1+ f 1.01
12000 0.00577 1.00577 24
(b) A= = $393.526 Ans.
1.00577 24 - 1

4.24)
12
0.08
ia =
1+ - 1 = 0.0829
12
( 1 + 0.0829 ) - 1
15 20
1
PW = 20000 15 = $34, 203.17
0.0829 ( 1 + 0.0829 ) 1 + 0.0829
i - f 0.08 - 0.03
=
i = = 0.0485
1+ f 1 + 0.03
0.0485
Monthly inf lation - free int erest rate = = 0.004
12
$34, 203.17 0.004 1.004240
A= = $221.95 Ans
1.004240 - 1

4.25)
4
0.09
ia =
1+ - 1 = 0.093
4
Equivalent Value of $800, 000 in actual dollar at the end of 63rd birthday
800, 000( F / P,5%, 40) = $5631991
(a) A( F / A, 2.25%,160) = 5631991

0.0225

A = 5, 631,991 = $3708.87 Ans.

(1 + 0.0225)160
- )
1

(b) A = G ( A / G ,9.3%, 40) = 1000 9.578 = $9578.28
( A1 + 9578.28) ( F / A,9.3%, 40 ) = 5, 631,991

( A1 + 9578.28)
(
1 + 0.093) - 1
40
)

= 5, 631,991

0.093

A1 = $5799.93 Ans.

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Fundamentals of Engineering Economics, 3rd ed. 2012

4.26)
(a) i = i
+ f + i
f = 0.07 + 0.06 + 0.07 0.06 = 0.1342 = 13.42% Ans
0.07
(b) A = { 50, 000 + 51, 000 1.07 + 52, 000 1.07 2 + 53, 000 1.073 } 8 = $22,323.2 Ans.
1.07 - 1

Given: i = 8% f = 6%
4.27) per year, per year

(a) Freshman-year expense in actual dollars:

$40,000(F / P,6%,10) = $71,632

(b) Equivalent single-sum amount at n = 0

i- f
i' =
1+ f
= (0.08 - 0.06) / (1 + 0.06)
= 0.01887
P = [$40,000( P / A,1.887%,3)
+ $40,000]( P / F,1.887%,10)
= $129,076.84

(c) Required annual deposit in actual dollars:

A = $129,076.84( A / P,8%,10) = $19,236.2

4.28)
(a) The average annual general inflation rate:
(1 + 0.065)(1+ 0.077)(1+ 0.081) = 1.2399
(1+ f )3 = 1.2399
f = 7.4308%

(b) Constant dollars:

n Actual Constant
dollars dollars
0 -$45,000 -$45,000
1 $36,000 $36,000(0.9390) = $33,804

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Fundamentals of Engineering Economics, 3rd ed. 2012

2 $46,000 $46,000(0.8718) = $40,103

3 $26,000 $26,000(0.8065) = $20,969
Conversion factors:
( P / F , 6.5%,1) = 0.9390
( P / F , 7.7%,1)( P / F , 6.5%,1) = 0.8718
( P / F ,8.1%,1)( P / F , 7.7%,1)( P / F , 6.5%,1) = 0.8065

(c)

P = -$45, 000 + $33,804( P / F ,5%,1)

+ $40,103( P / F ,5%, 2) + $20,969( P / F ,5%,3)
= $41, 682.52
4.29)
Saving $2,000 per month (actual dollars) for 10 years, i=0.8333% per month,
10 years = 120 months

$2, 000( F / A, 0.8333%,120) = $409, 680.57

Retirement income $10,000 per month (today dollar), i=0.5% per month, 20
years = 240 months, inflation rate: 4% per year = 0.3333% per month
$10, 000( P / A1 , 0.3333%, 0.5%, 240)( P / F ,10%,15) = $471,919.80

Contribution to college with $1,000,000 (actual dollars)

$1, 000, 000( P / F , 6%, 20)( P / F ,10%,15) = $74, 643.57

A vacation home in Sedona
$500, 000(1 + 0.04)10 = $740,122.14
Buying at year 10: in actual dollars

House value with increasing rate 5%:

$740,122.14(1 + 0.05)35 ( P / F , 6%, 20)( P / F ,10%,15) = $304, 734.26
Therefore, the required savings (A) in each month in years 11 through 25:

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Fundamentals of Engineering Economics, 3rd ed. 2012

A( P / A, 0.8333%,180) = -$409, 680.57 + $471, 919.80 + $74, 643.57

+$740,122.14 - $304, 734.5
= $572.270.68
A = $6,149.51
Let i be the effective interest rate per month. Then,
4.30)

(1 + i)12 - 1 = 0.0677
(1 + i )12 = 1 + 0.0677
i = ( 1 + 0.0677 )
1/12
-1
= 0.5474%

P = $10,000 +$100(P / A,0.5474%,480) = $26,938.67

4.31)
(a) Real after-tax yield on bond investment:
Nontaxable municipal bond:
0.09 - 0.03
i 'municipal = = 5.825%
1 + 0.03

Taxable corporate bond:

0.12(1 - 0.3) - 0.03
i'corporate = = 5.243%
1 + 0.03
The municipal bond provides a greater return on investment.

(b)
Given : i = 6%, f = 3%
and ,

i 'savings = 2.91%

i 'municipal i 'corporate
Since >2.91% and >2.91%, both bond

investments are better than the savings account. Now tocompare two mutually
exclusive bond investment alternatives, we need to perform an incremental
analysis.

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Fundamentals of Engineering Economics, 3rd ed. 2012

After-tax Cash Flow

n Municipal Corporate Incremental
0 -$10,000 -$10,000 0
1 $900 $840 -$60
2 $900 $840 -$60
3 $900 $840 -$60
4 $900 $840 -$60
5 $900 $840 -$60

We cannot find the rate of return on incremental investment,as returns from

municipal bond dominate those from corporate bond in every year. Municipal
bond is a clear choice forany value of MARR.

4.32)

Two common approaches may be used: either (1) constant dollar analysis or (2)
actual dollar analysis. In this case, it may be easier to use the constant dollar
analysis, as we dont need to project the future price increase of the
subscription, assuming that the price of magazine will follow the general
inflation rate. Then, we need to determine which interest rate to use in
evaluating the three different subscription options. Assuming that the decision-
i'
makers desired inflation-free interest rate ( ) or real earnings from his or her

personal investment is around 2%, we can determine the total subscription cost
for life-time (say, more than 50 years) as follows:

$39
P1-year subscription = $39 + = $1,989
0.02
$72
P2-year subscription = $72 + = $1,854
0.0404
$103
P3-year subscription = $103 + = $1, 786
0.06121

In this case, the 3-year subscription option appears to be a better choice. Note
that 4.04% represents the effective interest rate for 2 years and 6.121% does for

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Fundamentals of Engineering Economics, 3rd ed. 2012

3 years. The view taken in this calculation is that if the general inflation rate
were running at 3%, the decision-maker would earn around 5% (=3%+2%)
market interest rate. Certainly the choice will change depending upon the
individual decision-makers true earrings requirement.

If we take a finite planning horizon, say 6-year, the subscription cost for each
option would be as follows:

P1-year subscription = $39 + $39( P / A, 2%,5) = $222.82

P2-year subscription = $72 + $72( P / F , 2%, 2) + $72( P / F , 2%, 4) = $207.72
P3-year subscription = $103 + $102( P / F , 2%, 3) = $200.05

It still appears that the 3-year subscription is a better choice.

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