The Effects of Inflation in Engineering
Economic Studies
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Source: Bradford DeLong, http://www.j-bradford-delong.net/Econ_Articles/woodstock/woodstock4.html
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Producer Price Index -- All Manufacturing (1992-2002)
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Price trends in turbines and turbine generator sets
Source: US Bureau of Labor Statistics
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Producer price index for computers and work stations
Source: BLS
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Treatment of inflation in investment analysis
• Two alternatives:
– Estimate cash flows in actual (‘nominal’ or
‘current’) dollars, and use ‘market’ (‘nominal’)
interest rates
– Estimate cash flows in terms of the purchasing
power of the dollars of some base year (i.e., in
‘constant dollars’) and use real interest rates
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Relationship between future worth of construction project at time of
completion and ‘overnight cost’ in dollars of construction start year:
1) Uniform rate of expenditure (in constant dollars)
È1 - e yTe-xT ˘
Exact expression : F = ION e xT Í
˙
Î (x - y)T ˚
È
x+ y ˘
T˙
Approximate expression : F = ION Í1+
2
Î
˚
2. Sine - wave construction expenditure profile (constant dollars) :
È
˘
Í
˙
Í
˙
Í
˙
yt
xT
e
+
e
˙
Exact expression : F = I on Í
¸˙
Í Ï
Í Ô ( x - y )2 Ô ˙
˝˙
Í2Ì1+
2
Ô
Ô˙
p
Í
T ˛˚
Î Ó
( )
È Ê x + yˆ ˘
Approximate expression : F ª I on Í1+ Á
˜T ˙
Î Ë 2 ¯ ˚
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Effect of construction lead time on future worth of plant, F
6.00
5.00
F/ION
4.00
y=0.02,x=0.06
y=0.02,x=0.06(approx)
y=0.04;x=0.08;
3.00
y=0.04;x=0.08 (approx)
y=0.1;x=0.14
2.00
y=0.1;x=0.14 (approx)
1.00
0.00
2
4
6
8
10
12
14
Construction lead time, T (yrs)
Uniform rate of expenditure assumed (in constant dollars)
y= escalation rate
x= interest rate
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Interpretation of alternative capital cost measures
Ion: The ‘overnight cost’ of the project, expressed in dollars of the year of
construction start. This is what the plant would cost if there were no
inflation and no interest charges on capital, i.e., if the plant were built
‘overnight’. It consists of the direct costs of labor, materials,
equipment, engineering and design, etc.
F: The future worth of the project at the construction completion date. This
is the amount of money that, if paid to the constructor at the completion
of the project, would be just sufficient to cover all costs incurred during
construction, i.e., both the direct costs and the interest accruing on
funds borrowed (or equity invested) during construction. In the days
when power plants were constructed by regulated electric utilities, this
was also often referred to as the ratebase cost.
F-Ion: The ‘time-related’ costs of the project.
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Energy Information Administration. "An Analysis of Nuclear Power Plant Operating Costs." DOE/EIA-0511 (Washington,DC,1988).
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Costs in 1982
constant dollars
Energy Information Administration. "An Analysis of Nuclear Power Plant Operating Costs." DOE/EIA-0511 (Washington,DC,1988).
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Overnight costs given
in dollars of year of
construction start.
Energy Information Administration. "An Analysis of Nuclear Power Plant Operating Costs." DOE/EIA-0511 (Washington,DC,1988).
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Energy Information Administration. "An Analysis of Nuclear Power Plant Operating Costs." DOE/EIA-0511 (Washington,DC,1988).
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Energy Information Administration. "An Analysis of Nuclear Power Plant Operating Costs." DOE/EIA-0511 (Washington,DC,1988).
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Predicted construction costs for future nuclear power plants
Deutsch, John, Ernest Moniz et al. "The Future of Nuclear Power: An Interdisciplinary MIT Study." Massachusetts Institute of Technology,
2003 (ISBN 0-615-12420-8). Available at http://web.mit.edu/nuclearpower/. p. 137.
Source: MIT Nuclear Study
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Deutsch, John, Ernest Moniz et al. "The Future of Nuclear Power: An Interdisciplinary MIT Study." Massachusetts Institute of Technology,
2003 (ISBN 0-615-12420-8). Available at http://web.mit.edu/nuclearpower/. p. 138.
Predicted construction costs for future nuclear power plants
(contd.)
Deutsch, John, Ernest Moniz et al. "The Future of Nuclear Power: An Interdisciplinary MIT Study." Massachusetts Institute of Technology,
2003 (ISBN 0-615-12420-8). Available at http://web.mit.edu/nuclearpower/. p. 137.
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