If we want to apply multiple rates of inflation, we just need to build two separate indexes. On this slide, we're showing two different sets of costs, construction and maintenance costs. Construction is going up at 5% a year. Maintenance is going up at 10% a year, the 5% per year. We just build a construction inflation index, 1 plus 5% to the power of the number of years, and we multiply our construction costs without inflation times the inflation index to give us inflation adjusted construction costs. For the maintenance, we're using a separate higher rate of inflation, 10%, so the maintenance inflation index is 1 plus 10% to the power of the number of years that have gone by. So it goes 1.1, 1.21, 1.331, and so on.
We're also going to add in here a maintenance inflation flag that says there's no inflation until the third year. Maybe it's a fixed price deal, and we did what we've just done on the previous slide where we say, if the flag is a zero, just give me the cost before inflation, otherwise give me costs multiplied by the index.
What happens if inflation starts before the model? Maybe you are using cost estimates from 1 year, but the project and the model only start a couple of years later. The example we've got here, we are using cost estimates from 2021, but the project and model begins in 2023, so we need to add two years of inflation before the model even begins. In this case, we've got cash flows before inflation of 100 every year, and an inflation index 5% a year. But you can see it doesn't start at 1.05. It starts at 1.1 576. That's because we've got already before the model begins, we've got two years worth of inflation. By the time we get to year 1, we've got three years worth of compounding inflation at 5%. The formula that's used there is down at the bottom. It's 1 plus the 5% inflation rate to the power of the year number plus two extra years. So hence in period 1. We have three years worth of inflation. In the second year, we'll have four years worth. In the third year, we'll have five years worth. It's just a simple tweak to help us add in the correct amount of inflation. Given that our cost estimates are two years out of date, by the time the model commences.
