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Research Questions

  1. How accurate are today's inflation indices for estimating operations and maintenance (O&M) costs?
  2. Do current DoD discounting practices deliver least-cost decisions?
  3. How well are current inflation indices and discount rates serving DoD weapon-system program management today?

Inflation indices and discount rates are necessary tools in the Department of Defense's (DoD's) acquisition process, as the final selection of a system is partially based on potential increases in sustainment costs (inflation) and the present value of future costs (discounting). Inflation indices built for DoD use very broad categories that include operations and maintenance (O&M) as well as manpower, procurement, and research and development. This study addresses the question of how well current inflation indices and discount rates are serving DoD weapon-system program management. It investigates inflation rates for parts for the Abrams tank and the Bradley armored personnel carrier and shows that the two weapon systems, while both ground systems, experience inflation differently. Although government decisionmaking can benefit from discounting (taking into account the time value of money), choices made using discounted cash flows are not always the least expensive for DoD. Its O&M estimating strategies should be reviewed to reflect changing repair and other costs, since a range of reasonable courses of action exists for many DoD investment decisions. Recommendations for the Office of Cost Assessment and Program Evaluation to consider when evaluating the inflation and discounting policies that impact the long-term affordability of DoD programs include (1) revisiting O&M costs annually with a 5-year moving-average inflation, to reflect changing repair and other costs; (2) highlighting the role of supply chain surcharges in parts costs in cost estimates used to inform program financial analysis; (3) expanding analysis of investments to ensure consideration of least-cost outcomes.

Key Findings

Individual Indices Are Needed to Estimate Inflation for Different Weapon Systems, and Sensitivity Analyses Are Needed to Reach Optimum DoD Investment Decisions.

  • Different systems experience inflation differently, and individual indices are needed to make accurate decisions for present systems, as well as for future purchases.
  • Discounting practices do not always deliver least-cost decisions; sensitivity analyses are needed, because a range of reasonable courses of action exists for many DoD investment decisions.

Recommendations

  • Revisit O&M costs annually with a five-year moving-average inflation, using individual-system indices developed to assist the acquisition community.
  • Highlight the role of supply chain surcharges in cost estimates.
  • Expand analysis of investments to ensure consideration of least-cost outcomes.

Table of Contents

  • Chapter One

    Introduction

  • Chapter Two

    Cost Inflation of Ground-Vehicle Parts

  • Chapter Three

    The Value of Discounting

  • Chapter Four

    New Approaches to Inflation and Discounting

  • Appendix

    Inflation Estimates over Time

The research described in this report was prepared for the Office of the Secretary of Defense (OSD). The research was conducted within the RAND National Defense Research Institute, a federally funded research and development center sponsored by OSD, the Joint Staff, the Unified Combatant Commands, the Navy, the Marine Corps, the defense agencies, and the defense Intelligence Community.

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