ME 291

Engineering Economy
Lecture 26
Effect of Inflation

Faculty of Mechanical Engineering

Ghulam Ishaq Khan Institute, Topi, Swabi

ENGINEERING
ECONOMY
FW Calculation Adjusted for Inflation

• FW can have anyone of four

interpretations:
1. The actual amount that will be accumulated in time n.
F = P(1 + if)n = P(F/P, if, n)
2. The purchasing power of the actual money in time n
but stated in today’s dollars
P 1  i f  P  F / P, i f , n 
n

F 
1  f  n 1  f  n
• Recognizes that $1 in future purchases less than $1 now
• Can also be calculated by first finding real interest rate.

ENGINEERING
ECONOMY
FW Calculation Adjusted for Inflation

3. The # of future dollars required at time n to maintain the

same purchasing power as a dollar today.
F = P(1 + f)n = P(F/P, f, n)

4. The # of dollars required at time n to maintain purchasing

power and earn a stated real interest rate.
In this method if is calculated first and use in equivalence
formulae

ENGINEERING
ECONOMY
Types of Interest Rates

ENGINEERING
ECONOMY
Inflation adjusted MARR

• The inflation adjusted MARRf can be

found by: MARRf = i + f + i(f)
• Now the FW can be calculated as:
F = P(1 + MARRf)n = P(F/P, MARRf, n)

ENGINEERING
ECONOMY
Example 14.4

A mining company wants to determine whether it should buy now or

later for upgrading a piece of equipment used in deep mining
operations. If the company selects plan A, the equipment will be
purchased now for $200,000. however, if the company selects plan
I, the purchase will be deferred 3 years when the cost is expected
to rise rapidly $340,000. The company expects a real MARR of
12% per year. The averaged inflation rate is 6.75% per year. From
only an economic perspective, determine whether the company
should purchase now or later:
a) When inflation is not considered.
b) When inflation is considered.

ENGINEERING
ECONOMY
Capital Recovery Calculations Adjusted
for Inflation
It is important in Capital Recovery to include Inflation b’cos current capital
dollars must be recovered with future inflated dollars.
It is obvious that future dollars will have less buying power than today’s
dollars. Therefore, inflated interest rate should be used in calculations.
Example: If $1000 is invested today at a real interest rate of 10% per year
when the inflation rate is 8% per year, the equivalent amount that must be
recovered each year for 5 years in future dollars is
A = 1000(A/P, 18.8%, 5) = $325.59
On the other hand, the decreased value of dollars through time means
that investors can spend fewer present (higher value) dollars to
accumulate a specified amount of future (inflated) dollars. The annual
equivalent of F = $1000 is
A = 1000(A/F, 18.8%, 5) = $137.59

ENGINEERING
ECONOMY
Example 14.5

• What annual deposit is required for 5

years to accumulate an amount of
money wit the same purchasing power
as $680.58 today, if the market interest
rate is 10% per year and inflation rate is
8% per year?

ENGINEERING
ECONOMY