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1
•
Actual (current) dollars
(
A
n
)
–
Represent cash for year
n
actually received or paid at the
time of a cash flow transaction.
•
Constant (real) dollars
(
A
′
n
)
–
Represent cash for year
n
in terms of constant purchasing
power at a given base year.
–
Measure of worth, not of actual dollars received or paid.
–
Hypothetical purchasing power of future dollars at base year
Actual Dollars versus Constant Dollars
n
n
n
f
A
A
)
1
(
+
′
=
n
n
n
f
A
A
)
1
(
+
=
′
where
is the general inflation rate
f
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Actual Dollars versus Constant Dollars
38
.
86
$
)
05
.
0
1
(
100
$
)
1
(
3
=
+
=
+
=
′
n
n
n
f
A
A
Example:
Base year =
0
Future year
n
=
3
Actual dollars
A
n
=
$ 100
f
General inflation rate
=
5% per year
Constant dollars
A
′
n
=
$100 in year 3 is worth only $86.38
in constant dollars at base year (year 0)
3
Inflation:
Interest Rates
•
Market interest rate
(
i
)
–
Interest rate taking into account earning power
and
inflation
•
Inflationfree interest rate ( i
′
)
–
Interest rate for earning power with inflation effects removed
n
n
i
A
P
)
1
(
+
=
Using market interest rate
i
:
Present worth
n
n
i
A
P
)
1
(
′
+
′
=
Using inflationfree interest rate
i
:
Present worth
n
n
n
f
A
A
)
1
(
+
=
′
where
A
n
=
actual dollars
(e.g., $100)
=
constant dollars
(e.g., $86.38)
=
+
=
′
38
.
86
$
)
05
.
0
1
(
100
$
e.g.,
3
n
A
n
A
′
Present worth of year
n
dollars:
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This note was uploaded on 03/17/2010 for the course IOE 201 taught by Professor Dennisblumenfield during the Fall '09 term at University of MichiganDearborn.
 Fall '09
 DennisBlumenfield

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