Question

The inflation rates for 4 years are forecast to be 4%, 5%, 5%, and 7%. The interest rate exclusive of inflation is anticipated to be 7%, 9%, 6%, and 7% over this same period. If labor is projected to be $1400, $2200, $2800, and $1300 in then-current dollars, during those years, determine the present worth equivalent for labor cost.

Answer 1

Interest rate exclusive of inflation is real interest rate.

Real interest rate = Nominal interest rate - Inflation rate, so

Nominal interest rate = Real interest rate + Inflation rate

Nominal interest rate, year 1 = 7% + 4% = 11%

Nominal interest rate, year 2 = 9% + 5% = 14%

Nominal interest rate, year 3 = 6% + 5% = 11%

Nominal interest rate, year 4 = 7% + 7% = 14%

Present value (Current dollars) ($) = 1400 x P/F(11%, 1) + 2200 x P/F(14%, 2) + 2800 x P/F(11%, 3) + 1300 x P/F(14%, 4)

= 1400 x 0.9000** + 2200 x 0.7695** + 2800 x 0.7312** + 1300 x 0.5921**

= 1260 + 1692.9 + 2047.36 + 769.73

= 5769.99

~ 5770

**From P/F Factor table