Question

(Could you solve this by using a financial calculator and just telling me what I need to input) You would like to have the current equivalent in terms of today's buying power of $3,000 in years 4 5 and 6 How much would you have to invest in years 1, 2 and 3 (the same amount in each year in nominal terms) to fund this level of real consumption? You expect inflation to be 3% per year over that time period. Your investments earn 7% per year in nominal terms

Answer Choices:

$2,449 $2,779 $2,893 $2,836

Answer 1

Find the equivalent of today's buying power of $3,000 in years 4, 5 and 6 at 3% inflation; then find their present values at 7% discount rate. That will be:

• Year 4: $3,376.53 [that is, $3,000 x 1.03⁴]. It's present value is $3,376.53 / 1.07⁴ = $2,575.94
• Year 5: $3,477.82 [that is, $3,000 x 1.03⁵]. It's present value is $3,477 / 1.07⁵ = $2,479.64
• Year 6: $3,582.16 [that is, $3,000 x 1.03⁶]. It's present value is $3,582.16 / 1.07⁶ = $2,386.94
  Total = $7,442.52 [that is $2,575.94 + $2,479.64 + $2,386.94]

Now we have to find present value annuity factor of 7% for 3 years. That is 2.6243. So the investment shall be: $7442.52 (calc. above) / 2.6243 = $2,836

You cannot do the entire problem in one step using the financial calculator; you need to do it step by step as I have shown. You can just ease your steps using the financial calculator to find the annuity factor, exponential values, etc. is all.

Hope this helps.
Thank you!