Question

If an investment costing $2,000 is expected to generate real cash flows of $900 p.a. for three years and prices are expected to increase at a rate of 10% p.a., what is the real required rate of return if the nominal rate of return is 15%?

Select one:

a. 6%

b. 5%

c. 1.05%

d. 4.55%

Answer 1

1+nominal rate of return = (1+real rate of return)*(1+inflation rate)

Substituting available values, we have:

1.15 = (1+real rate of return)*1.10

Real rate of return = 1.15/1.1-1 = 4.55%

Answer: [d] 4.55%