Money inflation

An economic analysis generally involves more imcertain-ties than a thermodynamic analysis. In the above discussion, it has been assumed that each variable in the eco-norrric analysis is known with certainty. However, many values used in the calcirlation are uncertain. A sensitivity artalysis determines by how much a reasonable range of uncertainty assiuned for each uncertain variable affects the frrral decision. Sensitivity studies are recommended to irrvestigate the effect of major assmnptions about values referring to future years (e.g., cost of money, inflation rate, and escalation rate of fuels) on the results of an economic analysis. 

Equations (9-59), (9-60), (9-61), and (9-62) may be used as they stand to assess expenditure on energy-conservation measures since a constant amount of energy is saved in each year subsequent to the capital outlay. However, the annual cash flows Acf corresponding to the energy savings remain constant only if there is no inflation or if the money values are corrected to their purchasing power at the time of the capital expenditure. 

For many years, companies and countries have lived with the problem of inflation, or the faUing value of money. Costs—in particular, labor costs—tend to rise each year. Failure to account for this trend in predicting future cash flows can lead to serious errors and misleading profitabihty estimates. 

Table 9-15 shows that the total amount of tax actually paid over the 5-year period was 988,320. This becomes 5.34,272 in uninflated-money terms when the tax for each year is corrected to its purchasing power in Year 0, using / factors for the 20 percent inflation rate employed for the example. Calculations for other rates of inflation can also be made, and the results plotted as in Fig. 9-.30. 

The true rates of return L can be calculated from Eq. (9-116) to be 20, 9.09, 0, and —7.69 percent respec tively for generaf inflation rates of 0, 10, 20, and 30 percent. Thus, although the time required for a projec t with a payback period of 4 years to reach a nominal (DCFRR) of 20 percent is reduced from almost 9 years under conditions of no inflation to less than 3V2years for 30 percent inflation, the true rate of return that prevails for the latter condition is —7.69 percent, implying that the project loses money in real terms. 

It is also possible to combine (MSF) considerations with evaluation of the true discounted-cash-flow rate of return (DCFRR) by using Eq. (9-62). The relationship of Eq. (9-59) is independent of inflation if all money values are based on those prevailing in the startup year. For this case, Fig. 9-34 shows the true (DCFRR) reached in a given time, expressed as the number of elapsed payback periods for various values of the payback period. 

Another instance of differential inflation occurs when the prices of goods and services rise uniformly but the cost of borrowing money, the interest rate charged on a loan, does not rise. 

Cost Indices The value of money will change because of inflation and deflation. Hence cost data can be accurate only at the time when they are obtained and soon go out of date. Data from cost records of equipment and projects purchased in the past may be converted to present-day values by means of a cost index. The present cost of the item is found by multiplying the historical cost by the ratio of the present cost index divided oy the index applicable at the previous date. Ideally each cost item affected by inflation should be forecast separately. Labor costs, construction costs, raw-materials and energy prices, and product prices all change at different rates. Composite indices are derived by adding weighted fractions of the component indices. Most cost indices represent national averages, and local values may differ considerably. 

One mole of pennies is a lot of money. It s enough to pay all the expenses of the United States for the next billion years or so without accounting for inflation.)... 

Inflation depreciates money in a manner similar to, but different from, the idea of discounting to allow for the time value of money. The effect of inflation on the net cash flow in future years can be allowed for in a similar manner to the net present worth calculation given by equation 6.9, using an inflation rate in place of, or added to, the discount rate r. However, the difficulty is to decide what the inflation rate is likely to be in future years. Also, inflation may well affect the sales price, operating costs and raw material prices differently. One approach is to argue that a decision between alternative projects made without formally considering the effect of inflation on future earnings will still be correct, as inflation is likely to affect the predictions made for both projects in a similar way. 

Hamilton assumed that a large proportion of the Spanish treasure went to Germany, probably mostly to pay the important bankers to the Spanish Crown, the Fuggers of Augsburg. Coins of Germany are yet to be analyzed, but, except for this German destination, the results so far obtained lead us to question whether the American treasure had any real connection at all with the very real European inflation. We do not assert that the American treasure had no effect on the European economy we question whether it was real silver which caused money to become cheap or whether it was the expectation of silver. 

To define the economic performance of a manufacturing venture, an analyst must predict various sources and sinks of money throughout the lifetime of a project. In fact the investors invest a huge amount of money when they begin to build the chemical plant, but they will earn money from sales only when the plant is finished and operating. Owing to inflation and devaluation, future money is different from present money [13,15], Therefore, a future income needs to be discounted to its present value in order to evaluate the expected profitability of a chemical plant. Of course, when dealing with future events, nobody can be absolutely positive about prices, inflation rates, etc. Therefore many assumptions need to be... 

This plan is similar to squeeze-and-spend and also applies to retirees with modest incomes. It is specifically designed for those who enjoy saving more than spending and are happy building a nest egg. Splurging is not their style. They prefer to cover themselves with a security blanket of savings. Some go to extremes and deny themselves necessities like a proper diet. Spending money hurts these people, especially when they worry about inflation. 

If you want to be sure something is left when you die, here s a plan that will work for you. Harvard University s endowment fund developed a spending guideline in 1973 to ensure a person wouldn t prematurely run out of money. The rule assumes a balanced portfolio allocated half to stocks and half to bonds and cash equivalents. It limits the first-year withdrawal to four percent of the portfolio s total value. Then, in each following year, increase this amount by the previous year s rate of inflation. Continue in this manner from year to year. For example, if you have a 500,000 portfolio, you could withdraw 20,000 in the first year. If the rate of inflation were 3.5 percent that year, you could withdraw 20,700 the second year. 

A question many employees have is, How much money do I need to retire and maintain my preretirement lifestyle According to a growing field of research on investment withdrawals, in order to have a 100 percent inflation-adjusted probability of not running out of money over a 30-year period (based on the historical performance of stocks, bonds, cash, and inflation), retirees should not withdraw more than 4 to 5 percent of their investment portfolios on an annual basis (Cooley, Hubbard, and Waltz, 1998). A typical couple needs to plan for a minimum of 20 years of income at retirement (Burns, 1997). In essence, if you have 20 years of income in investments or some other vehicle, you will be secure. Where do you get those years of income ... 

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