P1 40 points In most of engineering economic analysis it is

P1 (40 points): In most of engineering economic analysis, it is assumed that prices are stable and a machine purchased today for $5,000 can be replaced for the same amount many years into the future. In fact, prices generally rise, so the stable price assumption tends to be incorrect Under what circumstances is it correct to use the \"stable price\" assumption when prices actually are changing P2 (60 points): You are looking to build a new office for your company. The project takes 3 years, and you are planning to start next year. Construction cost percentage increases, as well as current cost estimates are given in the table for a 3-year period. Assume a market interest rate of 25% and general price inflation of 5% over the 3-year period Cost Percentage Increase Item Structural metal and concrete Roofing materials HVAC and plumbing equipment Insulation material Labor Today\'s Cost Year 1 $120,000 $14,000 $35,000 $9,000 $85,000 ear 2 32% 2.5% 2.1% ear 3 65% 3.0% 5% 2.0% 1.6% 5.890 50% 45% 45% (a) What would the costs be for labor in Years 1, 2, and 3? (b) What is the present worth of the insulation cost of this project? (c) Calculate the future worth of the labor and insulation material cost portion of the project. (d) Calculate the present worth of the total construction project.

Solution

Solution:

P1-

Price stability is an economic situation in which price level doesn’t change much over the time and sustain the value of money over time. In this situation the price stability is able to absorb the inflation or deflation to achieve high level of economic activity and employment level.

Now if the prices are constant or changing at very low rate i.e. the price can be predictable. Also, if the inflation or deflation level is low around 2%. Then, it can’t affect the economic activity and financial stability because people spending will not get affected by this low level of inflation or deflation. In this case prices are changing but if the level of inflation is equal to the low rate of increase in price it makes price inflation at zero level. So, in this situation although the prices are increasing but it is not affecting the economic activity. So, in this case price stability assumption can be used.