Question

Allyson Gomez invests $8,000 today in an investment that earns 6 percent per year (compounded annually) for 25 years. The average inflation rate is expected to be 1.8 percent per year. She will have much more than $8,000 in 25 years BUT what would this future amount be if expressed in today’s dollars? a. $34,335 b. $21,981 c. $52,306 d. $12,496 e. $21,839

Answer 1

We can solve this problem using 2 steps.

Step 1: Find the future value of $8,000 in 25 years.
Step 2: Find the present value of the amount we got in step 1 using the inflation rate.

Step 1: Find the future of $8,000 in 25 years which earns 6% per year.

We can use the future value formula.

Where,
FV = Future Value
PV = Present Value
r = rate of return
n = number of years

Substituting the values, we get:

Step 2: Find the present value of $34,335 using the inflation rate of 1.8%

We can use the same formula with rearranging variables. That is:

Here, i = inflation rate.

Substituting the values in the formula, we get:

Therefore, the answer is b) $21,981.