Class_Nov12_2013_Lec22_ISE460(1)(1)

Inaon and cash flow analysis constant dollar analysis

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Unformatted text preview: 3  ­17,277 13.62 4 20,000 (1+0.05) ­4  ­16,454 17.73 Equivalence Calcula%ons under Infla%on Types of Interest Rate Market Interest Rate (i) Infla@on ­free Interest Rate (i’) Types of Cash Flows Es@mated in Constant Dollars Es@mated in Actual Dollars Types of Analysis Method Constant ­Dollar Analysis Actual ­Dollar Analysis Infla%on Terminology  ­ III   Infla%on ­free interest rate (i’): an es%mate of the true earning power of money when the infla%on effects have been removed (also known as real interest rate).   Market interest rate (i): an interest rate which takes into account the combined effects of the earning value of capital and any an%cipated changes in purchasing power (also known as infla%on ­adjusted interest rate). Infla%on and Cash Flow Analysis  Constant Dollar analysis   Es%mate all future cash flows in constant dollars.   Use i’ as an interest rate to find the equivalent worth.  Actual Dollar Analysis   Es%mate all future cash flows in actual dollars.   Use i as an interest rate to find the equivalent worth. When do we Prefer Constant Dollar Analysis?   In the absence of infla%on, all economic analyses up to this point is, in fact, the constant dollar analysis.   Constant dollar analysis is common in the evalua%on of many long ­term public projects, because governments do not pay income taxes.   For private sector, income taxes are levied based on the taxable income in actual dollars, so the actual dollar analysis is more common. Two Alternate Ways in Conduc%ng Actual Dollars Analysis •  Method 1: Defla%on Method...
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