Escalated Dollar, Constant Dollar, and Sensitivity Analysis Inflation t A rising general level of prices (or conversely, the

the general decline in the value of money as measured by what it will buy. It is not an American phenomena only. Virtually all of the other industrialized nations have experienced more rapid rates of inflation in recent years. More widely discussed economic phenomenon and has had profound and extensive impacts one nearly everyone's lives. Will have dramatic impact on mining because of it capital-intensive nature.

t Inflation, again . . . Prices tend to rise very unevenly some specific prices may be relatively constant while others actually falling. The rate of inflation varies with: (1) the particular currency and (2) the type of goods and services purchased. Price increase alone does not signify inflation. Firms are often able to escape some the burden of rapidly rising price by conserving, consuming less, or using substitutes whose prices are rising less rapidly. The same compound interest formulae are used to account for the effect of inflation. The effect of government spending on inflation: more money is spent than received ==> more money is circulated without a corresponding increase in productivity ==> inflation. Characteristics of Inflation Depreciation a declining tax shelter while other costs and prices continue to rise (due to inflation), depreciation remains tied to original purchase price and becomes a less effective tax shelter over time Working capital drain Any production delay or unexpected higher inflation will make it difficult to justify additional funds necessary for the project. Capital gains taxation taxes on the apparent increase, even though its value in constant dollars remains the same or even less. Price changes can frustrate the intent of long-term contract - since the rate of inflation varies, it can not be predicted with certainty, resulting in disturbed fashion that involves a debtor-lender relationship. Rapid price changes cause uncertainty - if one is not sure whether prices are going to increase, decrease, or remain the same, any contract that has a time dimension becomes hazardous because of uncertainty. Real resources are used up as decision-makers seek to protect themselves from inflation

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individuals will divert scarce resources from the production of desired goods and services to the acquisition of information on the future rate of inflation. t Measuring inflation by price index which measures the general level of prices in reference to a base year. Consumer Price Index (CPI) - Most widely used cost of living indicator in the country.  The CPI data are compiled monthly from surveys of 400 commodities by region and by commodity.  It uses 1967 as the base year and measures the average monthly change in price over time for a fixed-market basket of goods and services (food, doctor's fee, drugs, fuel, shelter, rent, and many more items). The base was later change to 1982-1984 base, and will be changed again to 1993-1995 base effective Feb. 1999. Two more indecies were formed in 1978 to reflect the different mix of goods and services which constitutes the cost of living to each group:

 CPI-U: covers all urban consumers, roughly 80% of the population; and  CPI-W: urban wage earners and clerical workers, covering roughly 50% of the individuals in the CPI-U index. Inflation Rate (f) f= This year's CPI previous year's CPI previous year's CPI

The indecies were 311 and 322 in 1984 & 1985 ==> prices were 211% & 222% higher in 1984 and 1985 than in 1967. Example, CPI1984 = 311; CPI1985 = 322 f1985 = 322-311 311 = 3.5%

Rule of 70 70 Approx. no. of years required to double inflation = % annual rate increase E.g., a 3% annual inflation will double the price level in about 23 ys. (703), while an 8% will double the price level in about 9 (708) ys. and 12% will double it in 6 ys.

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Producer Price Index (PPI) - Organized (from 10,000 monthly quotations) to be compatible with producer rather than consumer. An industry/commodity basis.

A stage of production basis. They catalogues prices for crude, intermediate, and semi-finished as well as finished products. Measure trends in prices for products other than finished goods. Although not commonly used to measure the general rate of inflation, it is useful in tracking the changing cost of doing business in various sectors. Gross National Product Implicit Price Deflator (GNPIPD) - It's getting popular recently.

Escalation A persistent rise in the price of specific commodities, goods or services due to a combination of inflation, supply and demand, environmental effects, market changes, political changes, engineering changes (screw-ups), labor contract changes, misc effects. Measuring Escalation Engineering News-Record (ENR) building and construction cost indexes; Marshall and Swift Cost Indexes (formerly Marshall and Stevens); Chemical Engineering (CE) Plant Construction Cost Index; Nelson Refinery Construction Cost Index

Constant and Escalated Dollars

Inflation rate in the U.S. is calculated based on the CPI, although the effects of these commodities on individuals are not uniform. In times of inflation, borrowers profit by paying off with inflated (cheaper) dollars, but interest rates set for high inflation can penalize if inflation slows down. Analysis may be made in terms of Escalated dollars or in Constant dollars (e.g., 1997 dollars). Since payments are always made in current dollars, it is usually easiest to work with those rather than with constant dollars.

Inflation Supply/Demand Technological changes Market Changes Environmental Effects Political Effects Miscellaneous Effects

Escalated $

Escalated Dollar Actual dollars of revenue or cost that will be realized or incurred at specified future points of in time, also referred to as current, inflated, or nominal dollars.

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Use escalation rate to bring money to a future point Inflation Supply/Demand Technological changes Market Changes Constant $ <== Environmental Effects Political Effects Miscellaneous Effects

<== Escalated $

Constant Dollar hypothetical constant purchasing power dollars obtained by present worthing escalated dollar values at the inflation rate to some arbitrary point in time, also referred to as real, or deflated dollars. Use inflation rate to bring money from a future point back to a specified point

Today's $

Escalation Rate; (F/P e,n )

Escalated $

Discount Rate; (P/F i*,n)

Present Value

e = escalation rate f = inflation rate i* = esc $ discount rate i*' = const $ discount rate

Discount Rate; (P/F f,n )

Discount Rate; (P/F i*',n) p. 210

Constant $

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