Solutions to end-of-chapter problems

Engineering Economy, 7th edition

Leland Blank and Anthony Tarquin

Chapter 14
Effects of Inflation
14.1 (a) There is no difference.
(b) Todays dollars are inflated compared to dollars of 2 years ago. Therefore, in order
for the dollars to have the same value (i.e., constant-value dollars) as 2 years ago,
divide todays dollars by (1 + f)2.
14.2 (a) During periods of inflation
(b) During periods of deflation
(c) When inflation is zero
14.3

0.10 = 0.04 + f + 0.04f

1.04f = 0.06
f = 0.0577 or 5.77% per year

14.4

if = 0.20 + 0.05 + (0.20)(0.05)

= 0.26 or 26%

14.5 if per month = 0.30/12 + 0.015 + (0.30/12)(0.015)

= 0.040375 or 4.0375% per month
Nominal if per year = 12(4.0375)
= 48.45% per year
14.6

0.35 = 0.25 + f + 0.25f

1.25f = 0.10
f = 0.08 or 8% per year

14.7

if = 0.04 + 0.01 + (0.04)(0.01)

= 0.0504 or 5.04% per quarter

14.8 if per month = 18/12 = 1.5%

Use inflation-adjusted interest rate equation to solve for i.
0.015 = i + 0.005 + (i)(0.005)
1.005i = 0.01
i = 0.00995 or 0.995% per month

14.9 Let CV = constant-value dollars

CV1 = 45,000/(1 + 0.05)1 = $42,857
CV2 = 45,000/(1 + 0.05)2 = $40,816
CV3 = 45,000/(1 + 0.05)3 = $38,873
CV4 = 45,000/(1 + 0.05)4 = $37,022
14.10 Future, inflated dollars = 10,000(1 + 0.05)10 = $16,289
14.11 Number of future dollars required = 1,500,000(1 + 0.04)30
= $4,865,096
14.12 Assume C1 is the cost today
2C1 = C1(1 + 0.07)n
(1 + 0.07)n = 2.000
n log 1.07 = log 2.000
n = 10.2 years
14.13 0.28 = i + 0.06 + i(0.06)
1.06i = 0.22
i = 0.2075 or 20.75%
14.14 (a) Inflation rate, f = [(2472.4 113.6)/113.6]*100
= 2076% per year
(b) Monthly inflation rate
Daily inflation rate

f = 2076/12 = 173% per month

f = 2076/365 = 5.68% per day

14.15 Buying power = 250,000/(1 + 0.04)5

= $205,482
14.16 (a) Constant-value dollars have to increase by only the real interest rate of 5% per year.
CV5 = 30,000(F/P,5%,5)
= 30,000(1.2763)
= $38,289
(b) if = 0.05 + 0.04 + (0.05)(0.04)
= 9.2%
F = 30,000(F/P,9.2%,5) = 30,000(1.55279)
= $46,584

14.17 Find f using F/P or P/F factor

5400 = 4050(F/P,f,5)
(F/P,f,5) = 1.3333
By factor equation
(1 + f)5 = 1.3333
1 + f = 1.33330.2
1 + f = 1.0592
f = 0.0592 or 5.92% per year
14.18 Price next year = 28,000(1 + 0.021)1
= $28,588
Price in 3 years = 28,000(1 + 0.021) 3
= $29,801
14.19 (a) Cost in todays dollars = $120,000
(b) Cost in future dollars = 120,000(1 + 0.028)2
= $126,814
14.20 If price had increased only by inflation rate,
Cost = 29,000(1 + 0.03)5
= $33,619
The salesman was not telling the truth.
14.21 (a) Cost of T & F = 0.28(52,000) = $14,560
(b) Cost of T & F 25 years ago = 14,560/(1 + 4.39) = $2701
(c)

MFI 25 years ago = 52,000/(1 + 1.47) = $21,053

% of MFI 25 years ago = 2701/21,053 = 12.8%

14.22 (a) At a 58% increase, $1 would increase to $1.58. Let x = annual percentage increase
1.58 = (1 + x)5
1.580.2 = 1 + x
1.096 = 1 + x
x = 0.096 or 9.6% per year
(b) 0.096 = 0.05 + f + 0.05f
1.05f = 0.046
f = 4.38% per year
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14.23 Pg = 350{1- [(1+0.03/1 + 0)31]/0 - 0.03}

= 350(50)
= $17,500
Savings = 17,500 350(31)
= $6650
or
Savings = 350(F/A,3%,31) 350(31)
= 350(50.0027) 10,850
= $6651
14.24 The two ways to account for inflation in PW calculations are:
(1) Convert all cash flow amounts into constant-value (CV) dollars, and
(2) Change the interest rate to consider inflation, that is, to account for the changing
currency value.
14.25

if = 0.10 + 0.04 + (0.10)(0.04)

= 14.4%
PW = 50,000(P/F,14.4%,2)
= 50,000[1/(1.144)2]
= $38,205

14.26

if = 0.10 + 0.04 + (0.10)(0.04)

= 14.4%
PW = 125,000(P/F,14.4%,3)
= 125,000(0.66792)
= $83,490

14.27

if = 0.12 + 0.03 + (0.12)(0.03)

= 15.36%
PW = 75,000(P/F,15.36%,4)
= 75,000[(1/(1.1536)4]
= 75,000(0.56465)
= $42,349

14.28

Convert all cash flows into CV dollars and then use i.

PW = 3000(P/F,8%,1) + [6000/(1 + 0.06)2](P/F,8%,2)
+ [8000/(1 + 0.06)3](P/F,8%,3) + 4000(P/F,8%,4)
+ 5000(P/F,8%,5)
= 3000(0.9259) + 5340(0.8573) + 6717(0.7938)
+ 4000(0.7350) + 5000(0.6806)
= $19,031
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14.29 The $1.9 million are then-current dollars. Use if to find PW

if = 0.15 + 0.03 + (0.15)(0.03) = 18.45%
PW = 1,900,000(P/F,18.45%,3)
= 1,900,000[(1/(1 + 0.1845)3]
= $1,143,269
14.30 (a) Use i = 10%
F = 68,000(F/P,10%,2)
= 68,000(1.21)
= $82,280
Purchase later for $81,000
(b) Use if = 0.10 + 0.05 (0.10)(0.05)
F = 68,000(F/P,15.5%,2)
= 68,000(1 + 0.155)2
= 68,000(1.334)
= $90,712
Purchase later for $81,000
14.31 Use the real i for salesman A and inflated if for Salesman B.
if = 0.20 + 0.04 + (0.20)(0.04) = 24.8%
PWA = -140,000 25,000(P/A,20%,10)
= -140,000 25,000(4.1925)
= $-244,812
PWB = -155,000 40,000(P/A,24.8%,10)
= -155,000 40,000(3.5923)
= $-298,692
Recommend purchase from salesman A
14.32 if = 0.12 + 0.04 + (0.12)(0.04)
= 16.48%
PWIWS = 2,100,000(P/F,16.48%,2)
= 2,100,000[(1/(1 + 0.1648)2]
= 2,100,000(0.73705)
= $1,547,806
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PWAG = $1,700,000
Select IWS
14.33 if per month = 0.01 + 0.004 + (0.01)(0.004) = 1.4%
PWS = 2,300,000(P/F,1.4%,120)
= 2,300,000[(1/(1 + 0.014)120]
= $433,684
PWL = 2,500,000(P/F,1.4%,120)
= 2,500,000[(1/(1 + 0.014)120]
= $471,395
14.34 Find present worth of all three plans.
Method 1: PW1 = $480,000
Method 2: if = 0.10 + 0.06 + (0.10)(0.06) = 16.6%
PW2 = 1,100,000(P/F,16.6%,5)
= 1,100,000(0.46399)
= $510,389
Method 3: PW3 = 850,000(F/P,6%,5)(P/F,16.6%,5)
= $850,000(1.3382)(0.46399)
= $527,775
CCS should select payment method 3
14.35 if = 0.10 + 0.06 + (0.10)(0.06)
= 16.6% per year
F = 10,000(F/P,16.6%,10)
= 10,000(1 + 0.166)10
= $46,450
14.36 Find F in future dollars using f = -3.0%
F = 50,000(1 0.03)5
= 50,000(0.85873)
= $42,937
14.37 Purchasing power = 100,000(F/P,10%,15)/(1 - 0.01)15
= 100,000(4.1772)/0.86006
= $485,687
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14.38 Buying power = 60,000(F/A,10%,5)/(1 + 0.04)5

= 60,000(6.1051)/1.21665
= $301,078
14.39 8,000,000(1 + f)4 = 7,000,000(F/P,7%,4)
8,000,000(1 + f)4 = 7,000,000(1.3108)
8,000,000(1 + f)4 = 9,175,600
(1 + f)4 = 1.14695
4[log (1+f)] = log 1.14695
4[log (1+f)] = 0.05954
log(1 + f) = 0.01489
1 + f = 100.01489
1 + f = 1.03487
f = 3.487% per year
14.40 (a) 25,000 = 10,000(F/P,i,5)
(F/P,i,5) = 2.5000
i = 20.1%

(solve F/P equation, interpolation or RATE function)

(b) 0.201 = i + 0.04 + i(0.04)

1.04i = 0.161
i = 15.48%
(c) Buying power = 25,000/(1 + 0.04)5
= $20,548
14.41 Cost = (3)32,350(1 + 0.035)2
= $103,962
14.42 (a) 1,400,000 = 653,000(1 + f)13
(1 + f) 13 = 2.14395
f = 6.04%
(b) The market rate is f + 5%.
if = 0.03 + 0.05
F = 1,400,000(1.08)11
= $3,264,295
14.43

if = 0.15 + 0.028 + (0.15)(0.028)

= 18.22%
F = 2,400,000(F/P,18.22%,3)
= 2,400,000(1 + 0.1822)3
= $3,965,374
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14.44 (a) Cost, year 20: machine A = 10,000(1.10)(1.10)(1.02)(1.02)(1.02)

= $31,617.58
Cost, year 20: machine B = 10,000(1.02)(1.02)(1.10)(1.10)(1.10)
= $31,617.58
The cost is the same.
(b) 10,000(1 + f)20 = 31,617.58
(1 + f)20 = 3.1618
20[log(1 + f)] = log 3.1628
log(1 + f) = 0.0250
1 + f = 100.025
1 + f = 1.05925
f = 5.925%
(c) Year 1: Machine A cost = 10,000(1.10) = $11,000
Machine B cost = 10,000(1.02) = $10,200
Year 2: Machine A cost = 11,000(1.10) = $12,100
Machine B cost = 10,200(1.02) = $10,404
Year 3: Machine A cost = 12,100(1.02) = $12,342
Machine B cost = 10,404(1.10) = $11,444.40
Year 4: Machine A cost = 12,342(1.02) = $12,588.84
Machine B cost = 11,444.40(1.10) = $12,588.84
Machine A will cost more than machine B in all years except years 4, 8, 12, 16, and 20.
14.45

14.46

F = P[(1 + i)(1 + f)(1 + g)]n

= 300,000[(1 + 0.10)(1 + 0.03)(1 + 0.02)]3
= 300,000(1.5434)
= $463,020
i f = 0.07 + 0.04 + (0.07)(0.04)
= 11.28%
AW A = -300,000(A/P,11.28%,10) 900,000
= -300,000(0.17180) 900,000
= $-951,540
AW B = -1,200,000(A/P,11.28%,10) 200,000 150,000
= -1,200,000(0.17180) 200,000 150,000
= $-556,160
Select Plan B
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14.47 Calculate amount needed at 5% inflation rate and then find A using market rate.
F = 72,000(1 + 0.05)3
= 72,000(1.1576)
= $83,347
A = 83,347(A/F,12%,3)
= 83,347(0.29635)
= $24,700 per year
14.48

if = 0.22 + 0.05 + (0.22)(0.05)

= 28.1%
A = 500,000(A/P,28.1%,5)
= 500,000(0.39572)
= $197,860

14.49

if = 0.15 + 0.05 + (0.15)(0.05)

= 20.75%
AWX = -65,000(A/P,20.75%,5) 40,000
= -65,000(0.33991) 40,000
= $-62,094
AWY = -90,000(A/P,20.75%,5) 34,000 + 10,000(A/F,20.75%,5)
= -90,000(0.33991) 34,000 + 10,000(0.13241)
= $-63,268
Therefore, select process X

14.50

if = 0.12 + 0.03 + (0.12)(0.03)

= 15.36%
A = -3,700,000(A/P,15.36%,5)
= -3,700,000(0.30086)
= $-1,113,182 per year

14.51

if = 0.10 + 0.04 + (0.10)(0.04)

= 14.4% per year
A = -40,000(A/P,14.4%,3) - 24,000 + 6000(A/F,14.4%,3)
= -40,000(0.43363) - 24,000 + 6000(0.28963)
= $-39,607 per year

14.52

if = 0.09 + 0.03 + (0.09)(0.03)

= 12.27% per year
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A = -180,000(A/P,12.27%,5) - 70,000(P/F,12.27%,3)(A/P,12.27%,5)
= -180,000(0.27927) - 70,000(0.70666)(0.27927)
= $-64,083 per year
14.53

if = 0.20 + 0.05 + (0.20)(0.05)

= 26% per year
(a) CR = A = 2,500,000(A/P,26%,5)
= 2,500,000(0.37950)
= $948,750 per year
(b) Now the $2.5 million is a future value
CR = A = 2,500,000(A/F,26%,5)
= 2,500,000(0.11950)
= $298,750
(c) Calculate CR at i = 20% for F = $2.5 million
CR = A = 2,500,000(A/F,20%,5)
= 2,500,000(0.13438)
= $335,950

14.54 Answer is (b)

14.55 Answer is (c)
14.56 Answer is (a)
14.57

0.16 = i + 0.09 + i(0.09)

1.09i = 0.07
i = 0.064
Answer is (a)

14.58 0.06 = i + 0.02 + (i)(0.02)

1.02i = 0.04
i = 3.92
Answer is (c)
14.59 Cost = 40,000/(1 + 0.06)10
= $22,336
Answer is (b)

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14.60 F = 1000(F/P,5%,25)
= 1000(3.3864)
= $3386
Answer is (b)
14.61 if = 0.06 + 0.04 + (0.06)(0.04)
= 10.24%
F = 1000(1 + 0.1024)10
= $2650.89
Answer is (c)
14.62 if = 0.04 + 0.03 + (0.04)(0.03)
= 7.12%
P = 50,000[1/(1 + 0.0712)6]
= $33,094
Answer is (c)
14.63 Answer is (d)
14.64 Answer is (b)

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Solution to Case Study, Chapter 14

Sometimes, there is not a definitive answer to a case study exercise. Here are example responses.

INFLATION VERSUS STOCK AND BOND INVESTMENTS

1. Stocks:
Bonds:

Overall i* = 6.6% per year

Overall i* = 5.0% per year

2. if = 0.07 + 0.04 + 0.04(0.07) = 11.28%

Stocks:

FS = 50,000(F/P,11.28%,5) - 1000(F/A,11.28%,5)

Bonds:

FB = 50,000(F/P,11.28%,5) - 2500(F/A,11.28%,5)

3. Stocks or bonds: FS = FB = 50,000(F/P,4%,5)

4. Subtract the future value of each payment from the bond face value 5 years from now.
Both amounts take purchasing power into account.
Stocks: FS = 50,000(F/P,4%,5) 1000(F/A,4%,5)
Bonds: FB = 50,000(F/P,4%,5) 2500(F/A,4%,5)

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5. Stocks: F = 50,000(P/F,11.28%,12) - 1,000(F/A,11.28%,12)

= 50,000(3.60583) - 1000(23.10134)
= $157,190
Bonds: P = 50,000(P/F,11.28%,12) + 2500(P/A,11.28%,12)
= 50,000(0.27733) + 2500(6.40666)
= $29,883
(Note: Goal Seek will find the answers, also. Target cells are row 17, the i* values set to
11.28% and changing cells are C15 for stocks and E3 for bonds.)
Do the answers seem reasonable?
Stocks: Possibly, if the economy and selected corporate stocks do very well.
Bonds: Probably not, the discount required is far more than given when a bond is
purchased. This is why, in part, the fixed-income investments are losers when
inflation is a sincere factor.

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