Handling Multi-year Cost Data:

Index Numbers, Escalation and

Discounting
Francis “Frank” Hall
DOE / Office of Cost Analysis (CF-70)
April 2010
 Multi-year Cost Data: Issues
Multi-year cost streams must often be adjusted for two
reasons:
 Escalation (inflation) – changes in the price level
 Future prices are likely to be higher
 More dollars must be budgeted to buy something farther in
the future
 Discounting – adjusting for the time value of money
 Even if there were no escalation, a dollar today is worth
more than a dollar next year

We will address these two issues in turn

2
 Outline
 Index Numbers

 Escalation Assumptions made by the DOE

Office of Cost Analysis

 Discounting and Analysis

3
 Escalation and Index Numbers

 Escalation rates are normally based on index numbers.

 Some contracts contain an economic rate adjustment
clause based upon an index to protect the contractors
from significant changes in prices.
 Social Security, Federal Retired Pay, Medicare, and some
other federal programs are adjusted annually by an index
(normally the Consumer Price Index) to protect the
recipients from inflation.
 To fully understand escalation rates, one needs to have a
basic understanding of index numbers

4
 Index Numbers Outline
 Describe the term index.
 Understand the difference between an
unweighted (simple) and a weighted index.
 Construct and interpret Laspeyres, Paasche,
and Fisher price indices.
 Understand a value index.
 Explain how the Consumer Price Index is
constructed and interpreted.

5
 Index Numbers
 An index number measures the relative change in
price, quantity, value, or some other item of
interest from one time period to another.
 A simple index number measures the relative
change in just one variable.
 A weighted index number measures the relative
changes in more than one variable.

6
 Types of Indices
 Unweighted/Simple Indexes
 Weighted Indexes
 Laspeyres Price Index
 Paasche Price Index
 Fisher’s Price Index
 Value Index
 Special Purpose Index
 Consumer Price Index
 Producer Price Index

7
 Simple Index Numbers
According to the Energy Information Administration (EIA),
In 2000 the average price of a gallon of unleaded regular
gas was $1.51.In 2007 it was $2.80.What is the index for
the price of a gallon of unleaded regular gas for 2007
based on 2000 prices?

P= Average Price of a Gallon of Gas in 2007 (100) =

Average Price of a Gallon of Gas in 2000

P= $2.80 (100) = 185.4

$1.51

This is an example of a simple index number

8
 Weighted Index Numbers
An index can be used compare the cost of living in one
location to another. Consider the following weights:
15% Food
30% Housing
6% Utilities
10% Transportation
7% Health
32% Miscellaneous (include other than the above)

How does the cost of living in Idaho Falls, ID compare

with Aiken, SC and Alexandria, VA?

9
 Weighted Index Numbers
An index can compare the cost of living in one location to
another. Consider the following indices

City Cost of Living Index

Idaho Falls, ID $60,000 90
Aiken, SC 86
Alexandria,VA 138

If the cost of living in Idaho Falls, ID is $60,000 a

year, how does that compare to the cost of living in
Aiken, SC and Alexandria, VA?

10
 Weighted Index Numbers
An index can compare the cost of living in one location to
another. Consider the following indices

City Cost of Living Index

Idaho Falls, ID $60,000 90
Aiken, SC $57,333 86
Alexandria,VA 138

How does the cost of living in Idaho Falls, ID

compare with Aiken, SC and Alexandria, VA?
Aiken, SC = $60,000 * (86/90) = $57,333

11
 Weighted Index Numbers
An index can compare the cost of living in one location to
another. Consider the following indices

City Cost of Living Index

Idaho Falls, ID $60,000 90
Aiken, SC $57,333 86
Alexandria,VA $92,000 138

How does the cost of living in Idaho Falls, ID

compare with Aiken, SC and Alexandria, VA?
Aiken, SC = $60,000 * (86/90) = $57,333
Alexandria, VA = $60,000 * (138/90) = $92,000

12
 Why Convert Data to Indices?
 An index is a convenient way to express a change in a diverse group
of items.
 The Consumer Price Index (CPI) encompasses about 400 items—
including golf balls, lawn mowers, hamburgers, funeral services, and
dentists’ fees. Prices are expressed in dollars per pound, box, yard,
and many other different units. Only by converting the prices of
these many diverse goods and services to one index number can
the federal government and others concerned with inflation keep
informed of the overall movement of consumer prices.
 Converting data to indexes also makes it easier to assess the trend
in a series composed of exceptionally large numbers.

13
 Why Convert Data to Indices?

Total U.S. national debt for FY 2008 was $9,985,000,000.

The estimated total national debt for FY 2009 is
$12,867,500,000. This increase of $2,882,500,000
is significant. Yet if the FY 2009 debt is expressed as
an index based on the FY 2008 debt, the increase is

Index = (2009 National Debt /2008 National Debt)*100

Index = (12,867,500,000/9,985,000,000)* 100 = 128.9

A 28.9% increase is much easier to understand.

14
 Escalation
 Why should I be interested in escalation?
 As part of the Root Cause Analysis (RCA)
Corrective Action Plan (CAP) CF-70 was
tasked to develop policy/guidance on definition,
development, and use of escalation rates based
on industry and geographic trends.
 This was one of my first tasks at DOE

15
 Escalation
 Why should YOU be interested in escalation?

 You can have the best cost estimate (in constant dollars) but if
you do not address escalation properly, your project profile
will be erroneous.

 One not only needs a good database to develop a good

estimate, but also appropriate inflation indices to project costs
into the future.

 DOE publishes rates that are to be used for your estimates

unless you can provide alternate rates with justification.

16
 BCI, CCI, and CEPCI Indices

 To develop the DOE indices, we looked at

three key construction indices which were:
 Construction Cost Index (CCI),
 Building Cost Index (BCI), and
 Chemical Engineering Plant Cost Index (CEPCI).

17
 Predicting the Future
 We use these indices to predict the future;
however, as a famous philosopher said:

―It is tough to make predictions,

especially about the future‖

….Yogi Berra
18
 Composition of CCI
The Construction Cost Index (CCI) comprises a
market basket of three commodities plus common
labor.
1%
6%

13%

Common Labor
Steel
Lumber
Cement
80%

The CCI consists of 80% labor and 20% material

19
 Composition of BCI
The Building Cost Index (BCI) comprises a ―market
basket‖ of three commodities plus skilled labor.
3%

10%

Skilled Labor
Steel
22% Lumber
65% Cement

The BCI consists of 65% labor and 35% material

20
 Composition of CEPCI (2002)
 The Chemical Engineering Plant Cost Index (CEPCI)
comprises a market basket of eight commodities and
two types of skilled labor.

The CEPCI consists of 45% labor and 55% material

21
 Historical and Predicted Rates

Why is there so much volatility in the CEPCI rates?

22
 Analysis of the CEPCI
 Since there was so much volatility in the
CEPCI, we decided to analyze the monthly
CEPCI rates going back to 2002.
 The four major components of the CEPCI are
Equipment, Construction Labor, Supervisory
Labor, and Buildings.
 A multiple linear regression of the data with
the line forced through the origin revealed the
following results:
23
 Determining CEPCI
Percentages
Regression Statistics
Multiple R 1.0000
R Square 1
Adjusted R Square 0.9863
Standard Error 0.0341
Observations 77
ANOVA
df SS MS F Sig F
Regression 4 18604651 4651162.73 4.01E+09 1.1E-299
Residual 73 0.084688 0.00116012
Total 77 18604651

Bi Sbi t Stat P-value Lower 95%Upper 95%

Intercept 0
Equip 66% 0.0002 2,687.0809 4.4E-184 0.6559 0.6568
C Labor 19% 0.0008 248.8889 1.1E-108 0.1868 0.1898
S Labor 9% 0.0006 160.8510 7.36E-95 0.0885 0.0907
Buildings 5% 0.0006 83.3028 4.06E-74 0.0497 0.0522
Total 0.9853

Equip 66.6%
C Labor 19.1%
S Labor 9.1%
Buildings 5.2%
Total 1.000

24
 Variability of CEPCI
Components
Structural supports Equipment
Percent Changes Buildings Engineering Supervision
by Month Construction Labor
8.00%
6.00%
4.00%
2.00%
0.00%
-2.00%
-4.00%
-6.00%
-8.00%
Ju 0 8

9
Ju 7

Fe 08

Ju 8

Fe 09
Se 07

O 7

Se 08

O 8
M 08

M 09
Ap 8

Ap 9
Au 07

D 07
Ja 07

M 08

Au 08

D 08
Ja 08

M 09
N 07

N 08

-0
0

0
0

-0

-0
-
n-

g-
p-

n-

n-

g-
p-

n-
-
-

-
-
r-

r-
b-

b-
l-

l-
-

-
ay

ay
ov
ec

ov
ec
ar

ar
ct

ct
Ju

Note the high variability of structural supports and equipment in the

CEPCI.

25
 Revised CEPCI Percentages

5%
9%
Equipment

Construction Labor
19% Supervisory Labor

Buildings
67%

The Regression showed the CEPCI to be 28% labor and

72% material. The large material component explains the
increased variability of the CEPCI. The next chart shows
what was developed to determine the DOE indices.
26
 Derivation of DOE Indices
Index Nuclear Scientific Admin Remediation
Laboratory Warehouse D&D
BCI 15% 33.3% 50%

CCI 10% 33.3% 50% 100%

CEPC I 75% 33.3%

 BCI: Building Cost Index

 CCI: Construction Cost Index
 CEPCI: Chemical Engineering Plant Cost Index

27
 DOE Escalation Rates
 DOE Office of Cost Analysis (CF-70) annually provides
escalation rate assumptions for DOE projects
 Used for the FY 2011 Congressional Budget Call.
 Also to be used for Project analyses
Scientific Admin/ Remediation/
Nuclear
Laboratory Warehouse D&D
FY Rate Index Rate Index Rate Index Rate Index
2009 -3.2 1.000 0.9 0.981 4.2 0.966 4.7 0.963
2010 -1.9 0.981 -0.3 0.977 0.9 0.974 0.9 0.972
2011 2.0 1.000 2.3 1.000 2.6 1.000 2.9 1.000
2012 1.9 1.019 2.2 1.022 2.4 1.024 2.4 1.024
2013 1.9 1.038 2.4 1.046 2.8 1.052 2.8 1.053
2014 1.9 1.058 2.4 1.071 2.8 1.082 2.8 1.083
2015 1.9 1.078 2.4 1.097 2.8 1.112 2.8 1.113
2016 1.9 1.099 2.4 1.123 2.8 1.143 2.8 1.144
2017 1.9 1.119 2.4 1.150 2.8 1.175 2.8 1.176
2018 1.9 1.141 2.4 1.178 2.8 1.208 2.8 1.209
2019 1.9 1.162 2.4 1.206 2.8 1.242 2.8 1.243
2020 1.9 1.184 2.4 1.235 2.8 1.277 2.8 1.278

28 Fundamentals of DOE Cost Estimating 22-26 March 2010

 Historical DOE Escalation Rates
Final 4QFY09 Escalation Rates (Nov 27, 2009)

Nuclear Scientific Laboratory Admin/ Warehouse Remediation/ D&D

FY Rate Index Rate Index Rate Index Rate Index

1990 1.2 0.635 2.0 0.573 2.6 0.531 2.5 0.523
1991 0.9 0.640 1.9 0.584 2.6 0.544 3.4 0.541
1992 0.0 0.640 1.9 0.595 3.5 0.563 3.1 0.558
1993 2.0 0.653 3.5 0.616 4.8 0.590 4.2 0.581
1994 3.0 0.672 3.3 0.636 3.5 0.611 3.5 0.601
1995 2.7 0.691 1.4 0.645 0.4 0.613 1.0 0.607
1996 1.0 0.697 2.6 0.662 4.0 0.637 3.5 0.629
1997 1.9 0.711 2.8 0.681 3.5 0.660 3.0 0.647
1998 0.5 0.714 1.1 0.688 1.5 0.670 1.9 0.660
1999 1.2 0.723 2.0 0.702 2.7 0.688 2.8 0.678
2000 1.0 0.730 1.2 0.710 1.3 0.696 1.6 0.689
2001 0.1 0.731 1.3 0.719 2.2 0.712 2.7 0.707
2002 1.8 0.745 2.1 0.734 2.4 0.728 3.1 0.729
2003 1.0 0.752 1.6 0.746 2.0 0.743 2.3 0.746
2004 12.7 0.848 10.8 0.827 9.3 0.812 8.3 0.807
2005 2.1 0.866 2.8 0.850 3.4 0.839 3.3 0.834
2006 8.1 0.936 5.3 0.895 3.0 0.865 3.0 0.859
2007 3.1 0.965 3.4 0.925 3.7 0.897 3.7 0.891
2008 7.0 1.033 5.0 0.972 3.5 0.927 3.3 0.920
2009 -3.2 1.000 0.9 0.981 4.2 0.966 4.7 0.963

29
 Escalation Rate Example
 Lets do a simple example of using escalation
rates.
 Using the nuclear index convert $100M in
FY1998 dollars to FY2008 dollars.

30
 Escalation Rate Example
 Lets do a simple example of using escalation
rates.
 Using the nuclear index convert $100M in
FY1998 dollars to FY2008 dollars.
 Answer:
 $100M * (FY2008 Index/FY1998 Index)
 $100M * (1.033/0.714) = $144.7M

31
 Escalation Rate Example
 Lets do a more complicated example using
escalation rates.

 We want to determine a cost estimating

relationship (CER) to predict the cost in
$FY09 of radiation detector Sites and Devices
in Eastern Europe and Russia.

32
 Database used for
Radiation Detectors
Fiscal Escalation Adjusted to RPM
Year Country Actual Costs Rate Index FY 2009$ Sites Quantities
FY07 Armenia 1,792,931 0.944 1,899,291 4 16
FY07 Azerbaijan 4,100,088 0.944 4,343,314 6 14
FY08 Estonia 778,168 0.991 785,235 2 3
FY06 Georgia 3,018,110 0.912 3,309,331 2 7
FY07 Georgia 4,821,530 0.944 5,107,553 6 30
FY04 Greece 7,866,000 0.843 9,330,961 4 52
FY08 Kazakhstan 8,214,631 0.991 8,289,234 8 27
FY08 Lithuania 1,678,634 0.991 1,693,879 3 17
FY03 Russia 10,940,228 0.761 14,376,121 19 113
FY04 Russia 10,036,000 0.843 11,905,101 20 174
FY05 Russia 10,396,578 0.867 11,991,439 19 35
FY06 Russia 11,990,344 0.912 13,147,307 10 123
FY07 Russia 16,617,441 0.944 17,603,221 29 92
FY08 Russia 22,133,070 0.991 22,334,077 43 94
FY08 Slovak Republic 650,676 0.991 656,585 5 10
FY07 Ukraine 3,993,737 0.944 4,230,654 5 17
185 824

Dividing the actual costs by the Scientific Escalation Rate

Indices provided FY 2009 constant dollars.

33
 Regression on
Actual/Current Dollars
Regression Statistics
Multiple R 0.9717
R Square 0.9442 = RegSS/Total SS
Adjusted R Square 0.8688
Standard Error 2,395,136
Observations 16

ANOVA
SS df MS F Sig F
Regression 1.3595E+15 2 6.79749E+14 118.49 0.00
Residual 8.0313E+13 14 5.73668E+12
Total 1.4398E+15 16

Coefficients Standard Error t Stat P-value Lower 95% Upper 95%

Intercept 0 #N/A #N/A #N/A #N/A #N/A
Sites 457,484 65,414 6.99 0.00 317,186 597,782
RPM Quantities 30,033 14,691 2.04 0.06 (1,476) 61,541

Note: The coefficient of determination (R2) is a relatively high

.9442, but the RPM Quantity variable is not significant.
How can one tell? Why is the intercept zero?
34
 Regression on
FY09 Constant Dollars

Regression Statistics
Multiple R 0.9729
R Square 0.9465 = RegSS/Total SS
Adjusted R Square 0.8713
Standard Error 2,556,727
Observations 16

ANOVA
SS df MS F Sig F
Regression 1.61932E+15 2 8.0966E+14 123.86 0.00
Residual 9.15159E+13 14 6.5369E+12
Total 1.71084E+15 16

Coefficients Standard Error t Stat P-value Lower 95% Upper 95%

Intercept 0 #N/A #N/A #N/A #N/A #N/A
Sites 447,682 69,827 6.41 0.00 297,919 597,446
RPM Quantities 45,459 15,682 2.90 0.01 11,825 79,094

Note: The adjusted coefficient of determination (R2) is about the

same as the previous example; however, both variables are
now significant. How can one tell?
35
 Weakness of the Indices
 The BCI and CCI are unweighted indices of 20 locations. The
indices would be more accurate if they were weighted.
 The BCI, CCI, CEPCI, PPI, and CPI yearly rates are based upon
monthly cumulative values. Global Insight uses cumulative
values for their yearly percent change calculations.
 Although I was unable to obtain a rationale for this, the main
reason given is in some instances, it can reduce variability.
Given the tremendous variability of commodities during the
past year DOE used a similar method.

36
 FY Month/Month vs. Cum Average

BCI FY 2008 FY 2009 % Change

September 4827 4764 -1.3%
Cum. Average 4619 4785 3.6%
CCI XXXXXXXX XXXXXXXX XXXXXXXX
September 8557 8586 0.3%
Cum Average 8181 8566 4.7%
CEPCI XXXXXXXX XXXXXXXX XXXXXXXX
September 608.9 525.6 -13.7%
Cum Average 564.7 532.8 -5.6%

The CEPCI Change for Sept 09/Sept 08 was -13.7%. This led
us to use the Cum Average/Cum Average for DOE Indices.

37
 Rationale for Monthly Indices
Former members of the DoD Cost Analysis Improvement Group disagree
with dividing the averaging cumulative indices.
 ―The idea of an annual deflator is to characterize the price of something in
year n, compared to the price of the same thing in year n-1. If the
reference month is December, then the annual deflator rate for year m is
the ratio of the price in December of year m+1, to the price in December
of year m, less one. ‖
-- Dr. David A. Lee, Ph D. Mathematics,
Author of ―The Cost Analyst’s Companion‖
 ―The December index shows the level at the end of the year, so if you are
looking for a year over year increase then Dec 08 / Dec 07 is appropriate.
The problem with the average indices is how do you weight it? If you do
not adjust for the seasonality of buying then you overweight and
underweight particular months.‖
-- Dr. David C. Trybula, Ph.D Economics

38
 Rationale for Cum Average
Indices
―As we discussed on the phone, utilizing annual PPIs or monthly
PPIs are both valid escalation methods; just be consistent.‖
For further assistance, please contact the PPI Section of Index
Analysis and Public Information at 202-691-7705.
Sincerely,
Antonio Lombardozzi
Producer Price Index
US Bureau of Labor Statistics

39
 Inflation and Escalation
Inflation is defined as a rise in the general level of
prices and goods and services in an economy over
period of time. It is an external economic effect.

Escalation is adjusting constant dollars to current/then

year dollars to account for the effects of inflation.

De-escalation is adjusting current/then year dollars to

remove the effects of inflation.

Inflation and Escalation are often used interchangeably.

40
 Basic Terms
 Current dollars, then-year (TY) dollars, and nominal dollars all mean the
same thing.These are Budget dollars.
 All refer to dollar amounts at some specified time or times stated in terms of
the prices then prevailing.
 A current dollar magnitude for a past year reflects prices that prevailed during
that year (not ―now.‖)
 A current dollar magnitude for a future year reflects a forecast of what the
prices will be then.
 Constant dollars and real dollars are synonyms. They are dollar
magnitudes at a specified time or times, stated in the prices of a (fixed)
reference time.
 Conversions between current dollars and constant dollars are
accomplished using a Price Index.
 A price index is generally understood as the ratio of the ―overall‖ or ―average‖
level of prices in one period relative to that of a base period. There are many
different types of price indices.
41
 Escalation and De-escalation
 First, Project costs should be estimated in terms of
Constant dollars.
 Second, Project budgets must be assembled in terms
of Then-Year dollars using escalation factors.
 Use GDP deflator from OMB or DOE Indices to
derive cost in terms of constant-value dollars, usually
called constant dollars.
 Use the GDP deflators to compute Net Present
Values (NPVs)

42
 OMB-Designated Discount Rates,
from OMB Circular A-94 (Dec 2009)

5.0%
4.4% 4.5%
4.5% Real Rate
Nominal Rate 3.9%
4.0%
3.5%
3.5% 3.1%
3.0% 2.7% 2.7%
2.5% 2.3% 2.2%
1.9%
2.0%
1.6%
1.5%
0.9%
1.0%
0.5%
0.0%
3-Year 5-Year 7-Year 10-Year 20-Year 30-Year
Project Duration

What inflation rates does OMB anticipate?

Why do these numbers increase over time?
What about different durations?
43
 Escalation Example

Nuclear Example FY 2011 FY 2012 FY 2013 FY 2014

Estimated Constant dollar project
cost (FY11$M) 500 1,000 2,000 250 = $3,750 FY11$M

DOE-nuclear price index (from table) 1.000 1.019 1.038 1.058

Then-Year/budget dollars (TY$M) 500 1,019 2,076 265 = $3,860 TY$ M

Start with cost stream estimated in Constant dollars

Multiply the constant dollars by the DOE Nuclear index to

develop the budget requirements in Then-Year dollars

44
 De-escalation Example
Scientific Example FY 2011 FY 2012 FY 2013 FY 2014

Then-Year budget dollars ($M) 600 1,100 2,200 600 = $4,500 TY$M
DOE –scientific price index (from
Table 1.000 1.022 1.046 1.071
Estimated Constant dollar project
cost (FY11$M)
600 1,071 2,103 560 = $4,334 FY11$M

Start with cost stream in Then-Year/budget dollars

Divide the Then-Year budget dollars by the DOE Scientific index
to develop constant dollars.

45
 Reminders
 Use Constant dollars when appropriate and use
current/then-year dollars when appropriate
 Constant dollars for costing
 Current/then-year dollars for budgeting
Use the appropriate DOE escalation index
 The draft DOE O 415.X requires OCA approval for the use
of an alternative escalation rate.
 An alternate rate requires
 (a) project title (b) total project cost or range (c ) reason
for the alternate escalation rate along with substantiating
data.

46
 Discounting

Because a (real) dollar today is worth

more than a (real) dollar tomorrow

47
 References
 OMB Circular A–94:Guidelines and Discount Rates for Benefit-
Cost Analysis of Federal Programs
 Executive Order 12893:Principles for Federal Infrastructure
Investments
 Benefits and costs should be measured and appropriately
discounted over the full life cycle of each project.
 DOE Guidance on Life-Cycle Cost Analysis: All dollar values
must be placed on a comparable basis for two reasons
 Money has real earning potential over time
(need to discount)
 The purchasing power of money erodes over time
(price escalation)

48
 Discounted Present Value
Compare program alternatives when costs and benefits
are distributed over time. Typical applications:

 Alternative Analysis

 Lease-versus-buy analyses

49
 Mechanics of Discounting
One Year: The present value of an amount (of money) R1 to
be received one year in the future where i is the annual rate
of interest. is defined as:

PV R1 
R1
1 i
Multi-Year: The generalization of the definition of present
value to a stream of costs C = Ct , t = 1, 2, 3, …, n is:

n
PV (C )   Ct /(1  i )t
1

50
 Simple Comparison of
Alternatives
Fiscal Year FY 2011 FY 2012 FY 2013 FY 2014 FY 2015 FY 2016 FY 2017 Total
Admin Warhouse 1.000 1.024 1.052 1.082 1.112 1.143 1.175

ALT 1 TY $M 248 463 970 916 410 3,007

FY11 $M 236 428 872 801 349 2,686
NPV 1.9% $M 227 404 809 729 312 2,482

ALT 2 TY $M 91 440 577 617 555 444 233 2,957

FY11 $M 91 430 548 570 499 388 198 2,725
NPV 1.9% $M 91 422 528 539 463 354 177 2,573

ALT 1 TY $M
Comparison of Alternatives - Admin/Warehouse Project ALT 2 TY $M
1200

1000
Millions in TY$

800

600

400

200

0
FY 2011 FY 2012 FY 2013 FY 2014 FY 2015 FY 2016 FY 2017
Fiscal Year

Which alternative is better?

51
 Choosing a Discount Rate
 Use the Treasury borrowing rate matched to:
 Duration of Cost and Benefit Streams
 Dollars in which the costs and benefits are stated—
Then-Year or Constant
 Timing of Costs and Benefits Within Individual Years
 The actual discount factor varies depending on your assumption
about when in the year costs and benefits occur
 Treasury Rates Are Updated in Annual Revisions to OMB
Circular A–94, Appendix C
 http://www.whitehouse.gov/omb/circulars/a094/a094.html
 Special considerations apply for analysis of regulations.
Consult OMB Circular A–94.
52
 Summary
 Use of multi-year cost streams has to consider
 Escalation: changes in prices
 Discounting: accounting for the time value of money

 Escalation
 Use constant dollars for project analysis
 Use then-year dollars for budgeting
 Use the appropriate index to convert

 Discounting
 Use net present value to compare alternatives
 Use the right discount rate
53
 Example
Using the Nuclear Index fill out the table below
Fiscal Year FY 2011 FY 2012 FY 2013 FY 2014 FY 2015 FY 2016 FY 2017 Total
Nuclear NA

ALT 1 TY $M 500 500 500 400 250 2,150

FY11 $M
*NPV 1.6% $M

ALT 2 TY $M 350 350 400 300 300 300 200 2,200

FY11 $M
**NPV 1.9% $M

*OMB Discount rate for constant dollars for 5 years is 1.6%

**OMB Discount rate for constant dollars for 7 years is 1.9%

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 Example Solution
Using the Nuclear Index to fill out the table below

Fiscal Year FY 2011 FY 2012 FY 2013 FY 2014 FY 2015 FY 2016 FY 2017 Total
Nuclear 1.000 1.019 1.038 1.058 1.078 1.099 1.119 NA

ALT 1 TY $M 500 500 500 400 250 2,150

FY11 $M 500 500 500 400 250 1,150
*NPV 1.6% $M 500 472 445 420 317 1,182

ALT 2 TY $M 350 350 400 300 300 300 200 2,200

FY11 $M 350 350 400 300 300 300 200 2,200
**NPV 1.9% $M 350 327 306 327 229 214 200 1,952

*OMB Discount rate for constant dollars for 5 years is 1.6%

**OMB Discount rate for constant dollars for 7 years is 1.9%

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 Discounting of Nominal Dollars
Using OMB Circular A-94 Rates

Fiscal Year FY 2011 FY 2012 FY 2013 FY 2014 FY 2015 FY 2016 FY 2017 Total
Nuclear 1.000 1.019 1.038 1.058 1.078 1.099 1.119 NA

ALT 1 TY $M 500 500 500 400 250 2,150

*NPV 3.1% $M 500 485 470 365 221 2,042

ALT 2 TY $M 350 350 400 300 300 300 200 2,200

**NPV 3.5% $M 350 338 373 271 261 253 163 2,009

*OMB Discount rate for nominal dollars for 5 years is 3.1%

**OMB Discount rate for nominal dollars for 7 years is 3.5%

Why are these totals higher than the previous example?

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 Discounting of Nominal Dollars
Using OMB Circular A-94 Rates

Fiscal Year FY 2011 FY 2012 FY 2013 FY 2014 FY 2015 FY 2016 FY 2017 Total
Nuclear 1.000 1.019 1.038 1.058 1.078 1.099 1.119 NA

ALT 1 TY $M 500 500 500 400 250 2,150

*NPV 3.1% $M 500 485 470 365 221 2,042

ALT 2 TY $M 350 350 400 300 300 300 200 2,200

**NPV 3.5% $M 350 338 373 271 261 253 163 2,009

*OMB Discount rate for nominal dollars for 5 years is 3.1%

**OMB Discount rate for nominal dollars for 7 years is 3.5%

Why are these totals higher than the previous example?

Ans: The projected OMB Inflation rates are lower than the
Nuclear Index (e.g. 1.6% vs 1.9% for 7 years)

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 Summary Questions
1. What are the four ―baskets‖ used to calculate DOE escalation
rates?

2. Which of these ―baskets‖ has recently shown the most

variability, and why?

3. In regression analysis how can one tell if the overall regression

is significant?

4. In regression analysis how can one tell if the independent

variables are significant?

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 Questions for Discussion

1. How have you been using escalation rates in your projects?

2. What suggestions do you have for improving the CF-70

escalation rates in the future?

3. What does the draft DOE O 415.X require?

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