The Effects of Inflation in Engineering Economic Studies

February 18, 2004

Source: Bradford DeLong , http://www.j- bradford- delong.net/Econ_Articles/ woodstock /woodstock4.html

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Nuclear Energy Economics and

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Producer Price Index -- A ll M anufacturing (1992-2002)

Price trends in turbines and turbine generator sets

Source: US Bureau of Labor Statistics

Producer price index for computers and work stations

Source: BLS

Treatmen t of inflatio n in investmen t analysis

• Tw o alternatives:

– Estim ate cash flow s in actual ( ‘ nominal’ or ‘ cur r ent’ ) dollars, and use ‘ market ’ ( ‘nom inal’ ) interest rates

– Estimate cash flows in terms of the purchasing power of the dollars of som e base year (i.e., in ‘ constant dollars ’ ) a nd use real in ter es t r ates

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)

xT  1  e yT e  xT ˘

Exact expression : F  I ON e

 (x  y)T 

Approxim ate expression : F = I

 x  y ˘

 T

ON  1 

 2 

2. Sine - wave construction expenditure profile (constant dollars) :

 ˘

 

 



Exact expression : F  I on 

e yt  e xT 

   

  ( x  y ) 2  

 2  1  2  

    

  T  

Approxim ate expression : F 

  x  y  ˘



I on  1 

2  T 

   

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Uniform rate of expenditure assumed (in constant dollars) y= escalation rate

x= interest rate

In terp retatio n of altern ative capital cost measu res

I on : The ‘overnight cost’ of the pr oject, expressed in dollars of the year of construction start. This is w hat the plant would cost if there were no inflation and no interest charges on capital, i.e., if the plant were b uilt ‘overnight’. It consists of the direct costs of labor, m aterials, equipment, eng ineering and d esign, et c.

F: The fut ure worth of the p roject at the construction completion dat e. T his is the amount of money that, if paid to the constructor at the completion of the p roject, would be just sufficient to cover all costs incurred du ring 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- I on : The ‘time-related’ costs of the project.

Energy Information Administration. "An Analysis of Nuclear Power Plant Operating Costs." DOE/EIA-0511 (Washington,DC,1988).

Costs in 1982 constant dollars

Energy Information Administration. "An Analysis of Nuclear Power Plant Operating Costs." DOE/EIA-0511 (Washington,DC,1988).

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).

Energy Information Administration. "An Analysis of Nuclear Power Plant Operating Costs." DOE/EIA-0511 (Washington,DC,1988).

Pre dicted constru ction costs fo r fu ture nuclear p ow er p lants

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. 13 7 .

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.

Pre dicted constru ction costs fo r fu ture nuclear p ow er p lants

( 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. 13 7 .

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Policy Analysis