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DOE G 430.1-1
CHAPTER 10

ESCALATION

1. INTRODUCTION

Escalation is the provision in a cost estimate for increases in the cost of equipment, material,
labor, etc., due to continuing price changes over time. Escalation is used to estimate the future
cost of a project or to bring historical costs to the present. Most cost estimating is done in
"current" dollars and then escalated to the time when the project will be accomplished. This
chapter discusses how escalation is calculated and how escalation indices are applied.
Additional information can be found in DOE Order 5700.2, COST ESTIMATING,
ANALYSIS AND STANDARDIZATION.

2. EXAMPLE OF USE OF ESCALATION

Since the duration of larger projects extends over several years, it is necessary to have a method
of forecasting or predicting the funds that must be made available in the future to pay for the
work. This is where predictive or forecast escalation indices are used. The current year cost
estimate is, if necessary, divided into components grouped to match the available predictive
escalation indices. Then each group of components is multiplied by the appropriate predictive
escalation index to produce an estimate of the future cost of the project. The future costs of
these components are then summed to give the total cost of the project. Escalation accuracy
for the total project increases with the number of schedule activities used in summation.

To properly apply escalation indices for a particular project, the following data is required:

escalation index (including issue date & index) used to prepare the estimate;

current performance schedule, with start and completion dates of scheduled activities; and

reference date the estimate was prepared.

Following is an example of a 5-year project that requires escalation calculations to determine
the total project costs in the base year's dollars.
TABLE 10-1

EXAMPLE OF 5-YEAR PROJECT
REQUIRING ESCALATION CALCULATIONS
ESTIMATE REFERENCE DATE: JULY 1, 1992

Step 1 Determine midpoint of scheduled activity.

Scheduled Activity

WBS

Start
Duration
Complete

(Months)

Midpoint

1. ED&I Title I
A1A
02/01/94
10/01/94
8
06/01/94

2. ED&I Title II
A1B
11/01/94
04/01/95
6
01/15/95

3. ED&I Title III
A1C
04/01/95
01/01/99
45
02/15/97

4. Equipment Procurement
(General Services)

B2A

10/01/94

10/01/97

04/01/96

5. Equipment Procurement
(Long-Lead, GFE)

B2B

04/01/95

12/01/95

08/01/95

6. Facility Construction
B2C
07/01/95
08/01/98
37
01/15/97

7. Demolition Work
D1A
01/01/98
09/01/98
8
05/01/98

8. Project Management
E1A
02/01/94
01/01/99
59
07/15/96

Step 2 Select appropriate escalation rates (assume escalation rates are for 1992 base year).

FY-1992 = 1.0

FY-1995 = 3.5

FY-1993 = 2.4

FY-1996 = 3.7

FY-1994 = 3.1

FY-1997 = 3.8

TABLE 10-1 (continued)

EXAMPLE OF 5-YEAR PROJECT
REQUIRING ESCALATION CALCULATIONS
ESTIMATE REFERENCE DATE: JULY 1, 1992

Step 3 Calculate appropriate escalation rates for each scheduled activity using estimate preparation date as
starting point and apply escalation rates selected in Step 2 to midpoint dates determined in Step 1.

For Example: ED&I - Title III (midpoint = 02/15/97)

FY-Period

Years x Escalation Index = Escalation Factor

07/01/92 to 01/01/93

6/12
.010
.005

01/01/93 to 01/01/94

1.0
.024
.024

01/01/94 to 01/01/95

1.0
.031
.031

01/01/95 to 01/01/96

1.0
.035
.035

01/01/96 to 01/01/97

1.0
.037
.037

01/01/97 to 02/15/97

1.5/12
.038
.005

Compound Escalation

Factor = 1.005 x 1.024 x 1.031 x 1.035 x 1.037 x 1.005 = 1.144 OR 14.4%

Step 4 The compound escalation factors derived in Step 3 are then applied to the total costs (direct cost +
mark ups) for each scheduled activity. Total project escalation is the summation of escalation for all
project activities

Assume costs for Title III design are $100,000 for the base year. The escalated value would be:

$100,000 x 1.144 = $114,400.

Thus, the cost used for Title III designs in the total project cost is $114,400.

Note: Repetition of calculations is obvious; thus, application to a computerized escalation rate analysis forecast program
would prove beneficial. Escalation rates applied to scheduled activities are practically tied to the project WBS.
Unless a better determination can be made and supported, the midpoint of cash flow for a particular category is
set equal to the midpoint of the scheduled activity for that category.

3. ESCALATION RELATIONSHIPS

To compare the costs of projects with differing durations, inflation/escalation costs must be
considered. Escalation in cost estimating has two main uses: to convert historical costs to
current costs (historical escalation index) and to escalate current costs into the future
(predictive escalation index) for planning and budgeting. Historical costs are frequently used
to estimate the cost of future projects. The historical escalation index is used to bring the
historical cost to the present and then a predictive escalation index is used to move the cost
to the future.

Associated with escalation are concepts of present and future worth. These represent
methods of evaluating investment strategies like life cycle cost analyses. For example, a
typical life cycle cost evaluation would be determining whether to use a higher R factor
building insulation at a higher initial cost compared to higher heating and cooling costs over
the life of the building resulting from a lower R factor insulation. Present and future worth
are discussed in Chapter 23.

A. Historical Escalation

Historical escalation is generally easily evaluated. For example, the cost of concrete
differed in 1981 versus 1992. The ratio of the two costs expressed as a percentage is
the escalation and expressed as a decimal number is the index. Generally, escalation
indices are grouped. For example, all types of chemical process piping may be grouped
together and a historical escalation index determined for the group.

B. Predictive Escalation

Predictive escalation indices are obtained from commercial forecasting services, such as
DRI/McGraw Hill, which supplies its most current predictions using an econometric
model of the United States economy. They are the ratio of the future value to the
current value expressed as a decimal. Predictive escalation indices are typically
prepared for various groups and may be different for different groups. For example,
the escalation index for concrete may be different than the one for environmental
restoration.

C. Escalation Application

Economic escalation shall be applied to all estimates to account for the impact of broad
economic forces on prices of labor, material, and equipment in accordance with the
following requirements.

Escalation shall be applied for the period from the date the estimate was prepared
to the midpoint of the performance schedule.

Since economic escalation rates are revised at least annually, all estimates shall
include the issue date of the escalation rates used to prepare the estimate.

Costs used for design concept shall be fully escalated and referenced as required.

4. ESCALATION INDICES

Costs continuously change due to three factors: changing technology, changing availability
of materials and labor, and changing value of the monetary unit (i.e., inflation). Cost or
escalation indices have been developed to keep up with these changing costs. The use of
escalation indices is recommended by DOE to forecast future project costs. The use of an
established index is a quick way to calculate these costs. To ensure proper usage of an
index, one must understand how it is developed and its basis.

A. Developing Escalation Indices

An escalation index can be developed for a particular group of projects. The projects
are divided into their elements, which can be related to current industry indices. The
elements are then weighted and a composite index is developed. Complete details on
developing escalation indices can be found in the DOE Cost Guide, Volume 5, on How
to Construct and Use Economic Escalation Indices.

B. Escalation Indices Published by DOE

DOE has developed construction escalation indices for various types of projects.
These are published every February and August. A copy of the latest indices can be
requested from Office of Infrastructure Acquisition (FM-50).

5. USE OF DOE ESCALATION INDICES

A. How to Select an Index

An index for a project or program is selected based on the type of project (i.e., the
scope of work). DOE publishes several indices to cover the range of projects for DOE.
If a project or program does not appear to fall into any of the categories, adjustments
can be made and must be submitted to FM-50 prior to their use.

More specifically, they must be selected based on the type of cost being escalated since
escalation indices represent groups of items. For example, a predictive escalation index
for chemical process piping would be inappropriate for use with a cost estimate for a
building construction project.

B. How to Apply an Index

The indices are developed with a base year whose index number is 1.0. Generally, the
base year is the current year. Once the index is selected, it can be used to either project
a current cost based on historical costs, or it can be used to project future costs based
on today's dollars.

C. Limitations

Cost indices have limitations since they are based on average data. Thus, judgement is
required to decide if an index applies to a specific cost being updated. If using an index
for a long-term project, it must be remembered that the long-term accuracy for indices
are limited. However, their usefulness to DOE is that the different groups within DOE
can use a common index to produce comparable costs.