Adjustment for Inflation

To include the impact of inflation on your cost budget, today’s costs and the estimated costs for the same events at the end of the study should be averaged.  This will result, in paying the service providers less than the cost budgeted amount in the early years of a study - creating a cash balance.  In the later years, the study will pay the service providers more than the cost amount budgeted, consuming the cash balance created in the early years of the study. 

 

There are at least two methods you can use to determine this average cost.  Both methods will require you to determine:     

1. The inflation rate that you will use in the calculation – i.e., the inflation rate.   

2. The number of years from today until the estimated last time the event will occur – i.e., the number of years. 

 

The first method is using Exponential Powers – a number (base) that is multiplied by itself for a defined number of times (the power).   Or, the base of 10 to the power of 4 would be 10 * 10 * 10 * 10.  Using this method, the assumed inflation rate plus one will become the base.  The power will be defined as the number of years the event(s) is estimated to occur minus one year as the current year does not need to be inflated. So the base = 1+ assumed interest rate and the power is the number of years the expense is estimated to be incurred minus 1. 

To include the impact of inflation on your cost budget, today’s costs and the estimated costs for the same events at the end of the study should be averaged.  This will result, in paying the service providers less than the cost budgeted amount in the early years of a study - creating a cash balance.  In the later years, the study will pay the service providers more than the cost amount budgeted, consuming the cash balance created in the early years of the study. 

 

There are at least two methods you can use to determine this average cost.  Both methods will require you to determine:     

1. The inflation rate that you will use in the calculation – i.e., the inflation rate.   

2. The number of years from today until the estimated last time the event will occur – i.e., the number of years. 

 

The first method is using Exponential Powers – a number (base) that is multiplied by itself for a defined number of times (the power).   Or, the base of 10 to the power of 4 would be 10 * 10 * 10 * 10.  Using this method, the assumed inflation rate plus one will become the base.  The power will be defined as the number of years the event(s) is estimated to occur minus one year as the current year does not need to be inflated. So the base = 1+ assumed interest rate and the power is the number of years the expense is estimated to be incurred minus 1. 

Example:

1. The department feels that a standard inflation rate of 5% per year would be reasonable.  Therefore, the base of the exponential factor is 1.05 (or the assumed inflation rate of .05 plus 1).   

2. The number of times this base is multiplied by itself is the power.  In this case, the study is expected to last 15 years.  Therefore the power is 14 (estimated number of years is 15 less the current, base year).   

3. So the inflation factor would be calculated as 1.05 to the power of 14 or: = 1.05 * 1.05 * 1.05 * 1.05 * 1.05 * 1.05 * 1.05 * 1.05 * 1.05 * 1.05 * 1.05 * 1.05 * 1.05 * 1.05  or in the Excel formula format 1.05 ^ 14 = 1.980   

4. To calculate the future cost, the current cost would be multiplied by the above 1.980.  So if the current cost was $300, the future cost would be $593.98 (or 300 * 1.980).   

5. The average cost of these two “endpoints” can now be calculated ending in $446.99 or ($300+$593.98)/2.  This is the amount you should use in the CU Anschutz’s cost budget.     

6. These two Excel functions can be combined to result in = (((1.05 ^ 14)*300)+300)/2   

The formula example in #6 above, can be updated with the inflation rate assumption, the number of years the expense will be incurred, and the current cost in the CU Anschutz cost budget worksheet to include the effect of inflation unique to each study.

To assist with making this formula easier and shorter, the following table can be used to determine the “inflation factor”.  This “factor/number” would then be multiplied by the current cost to arrive at the future cost of the expense.  Reusing the example outlined above, the current cost of the expense would be multiplied by 1.980 to arrive at the future cost of the expense item – or the intersection of 5% and 15 years and the resulting formula in the cost budget worksheet would be ((1.980*300)+300)/2:

Please note that when this table is used, the number of years the expense is expected to be incurred does not need to be reduced by “one”.  This “adjustment” is included in the calculation itself contained in the body of the table.  If an expense is expected to be incurred for 5 years, you would use the “5 Years” row.

The FV formula is a general formula that can be used for several different scenarios.  As a result, it includes some variables that will not be used in this instance such as an annual payment amount.  Since, in this case we are calculating the future value (FV) of a single amount rather than an FV with periodic payments, this variable may be left blank.   

In addition to not using the periodic payments variable, there is a second related variable call “type” in the Excel formula.  This variable can also be left blank. 

 

The full formula that Excel will prompt you for is: 

=FV(annual interest rate, number of years minus 1, amount of annual payments, current expense amount, “type”) 

Leaving the annual payments and “type” blank, the modified formula will us the following format:  = (FV(annual interest/inflation rate, number of years minus 1, , current expense amount))*-1 

The table below provides an example:

Either method can be used, but should be added to the Cost Budget Worksheet at the bottom – after the Total Direct Cost per visit has been calculated: