Presentation Transcript
Slide 1:Examples on the equivalence calculations with inflation
Example :Example SAFCO produces ammonia for local and international markets.
The ammonia production is a process to combine hydrogen with nitrogen at high temperature, and the steam is then converted to liquid.
SAFCO would like to increase its production of ammonia by installing chillers.
The increase in production due to better cooling system will bring to the company an annual profit of 2,000,000 riyals, in today’s prices.
Spare parts for the chillers are expected to increase by 5% per year due to inflation.
Slide 3:The life of the plant is expected at 20 years.
The market interest rate for SAFCO is 12%.
What is the worth of installing the chillers, using 2008 as the base year?
Since the profit is in real terms, we use the inflation free interest rate:
0.12 = i' + 0.05 + 0.05 i' ï‚® i' = 6.7% ï‚» 7%
The present worth of the uniform future profit series is
P = 2 (P/A, 7%, 20) = 2 (10.5940)
= 21,188,000 riyals
Mixed-Money Analysis :Mixed-Money Analysis When some cash flow elements are expressed in real terms and other elements in actual terms, we are presented with a complicated case.
The mixed money problem can be handled best by breaking the problem down into two cash flows; real money and actual money.
On the real money cash flow, use the inflation-free interest rate.
On the actual money cash flow, use the market interest rate.
Example :Example Dar Alarkan will start a new housing project.
The project will be started after 12 years from now.
The project will be accomplished in four stages, every stage will last one year.
The cost of each stage is expected at SR 30 million in real terms.
The cost of construction material (cement and steel) is estimated to increase by 3% annual.
To accumulate the necessary fund for the project, the company will open up an investment account that will pay 2% quarterly interest.
Slide 6:How much the company has to deposit every quarter?
The future worth of the investment after 12 years or 48 quarters is
F = A (F/A, 2%, 48)
= 79.3535 A
The annual project costs in actual terms are:
Slide 7:The equivalent cost of the construction costs in year 12 is
P = 44.056 (P/F, 2%, 4) +
45.3777 (P/F, 2%, 8) +
46.739 (P/F, 2%, 12) +
48.1412 (P/F, 2%, 16)
= 151.3527 million riyals
The required quarterly investment for 12 years is
A = 151.3527 / 79.3535 = SR 1.9073 million