1) Undertake an inflation rate of 5% per year and a market interest rate is 6%...

1) Undertake an inflation rate of 5% per year and a market interest rate is 6% above the inflation rate. Determine: (a) the number of constant-value dollars 6 years in the future that is equivalent to $40,000 now (b) the number of future dollars that will be equivalent to $40,000 now.

Solutions

Expert Solution

a) Inflation rate = 5% or 0.05

Market interest rate = 5% + 6% = 11% or 0.11

Real discount rate (i) = [(1 + Nominal discount rate) / (1 + Inflation rate)] - 1

= [(1 + 0.11) / (1 + 0.05)] - 1

= (1.11 / 1.05) - 1

= 0.057 or 5.7%

Present value = Future value / (1 + i)ⁿ

= 40,000 / (1 + 0.057)⁶

= 40,000 / 1.3946

= $28,682

The number of constant value dollar is $28,682.

b) Future value = P (1 + i)ⁿ

= 40,000(1 + 0.057)⁶

= 40,000 * 1.3946

= $55,784

The number of dollar in future is $55,785 that is equivalent to $40,000 now.

Rahul Sunny answered 2 years ago

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