Question

Profit that will be paid two years from now that would result from a possible investment project are 132.These are real profits. At the end of two years, the project is over and it has no resale value. Everyone agrees that the real interest rate will be 0.02 for the first year and .03 for the next year. It is expected that the inflation rate will 15% for the next year, and it will be 20% for the year after next. What is the present value of profits?

A)91.05 B)104.35 C)125.64 D)None of the above

Answer 1

Profits that will be paid two years from now that would result from a possible investment project are 132.These are real profits.

At the end of two years, the project is over and it has no resale value.

Everyone agrees that the real interest rate will be 0.02 for the first year and .03 for the next year.

It is expected that the inflation rate will 15% for the next year, and it will be 20% for the year after next.

What is the present value of profits?

Answer will be nearer to –

A)91.05

For the 1st year the interest rate will be 2% + 15% of 2% + 15% = 17.3%

For the 1nd year the interest rate will be 3% + 20% of 3% + 20% = 23.6%

PW of 132 at the end of 1^st year = 132 (1+.236) ^-1 = 106.8 (at interest is 23.6%)

PW of 106 at the end of 0^th year = 106.8 (1+.173) ^-1 = 91.05 (at interest is 17.3%)