Question

"Consider the following cash flow in actual dollars. The inflation rate is 4.9%. The inflation-free interest rate is 11.6%. What is the net present worth of the cash flow?
The cash flow in actual dollars for year 0 through 3 is -$42, $22, $22, and $31 respectively."

Answer 1

We need to find the interest rate, i = ?, given f= 4.9%
Inflation free interest rate formula is, If = (i-f)/(1+f),
If*(1+f) = (i-f)
0.116*(1+0.049) = (i-0.049)
0.12064 = i-0.049
i = 0.12064 +0.049 = 0.16964 = 16.96 percent

So, interest rate = 16.96 percent, inflation = 4.9%

NPW

1. cashflow*infaltion = Compounded cashflow

2. sum of (Compounded cashflow*Discounting factor) = NPW

Y	Cashflow	CF at inflation rate,	Compounded cashflow	DF at interest rate, 16.964 %	NPW
0	-42	1	-42	1.00	-42.00
1	22	1.049	23.08	0.8550	19.73
2	22	1.1004	24.21	0.7310	17.70
3	31	1.1543	35.78	0.6249	22.36
				NPW	17.79