Question

a.   If the market interest rate is 8% and the current inflation-free interest rate is 4.85%, what is the inflation rate? [3 points]
b.   The Transocean Inc. plans to make a five-year period payment to offset its one bad debt in an account. The payments begin with a $3,000 payment at the end of the first year. The payments then increase at the rate of 2% per year. Assume that the average general inflation rate is 8%, and the market interest rate is 4% during this five-year period.
Calculate the inflation free interest rate.
What is the equivalent present worth of the automobile?

Answer 1

A.

Inflation rate = (1+8%)/(1+4.85%) -1

Inflation rate = 3%

(Using shortcut)

Inflation rate = 8% - 4.85%

Inflation rate = 3.15%

==

B.

Inflation free interest rate = (1+4%)/(1+8%) -1

Inflation free interest rate = -3.7%

(Using shortcut)

Inflation free interest rate = 4% - 8%

Inflation free interest rate = -4%

==

Time = 5 years

Payment in year 1 = $3000

g = 2%

R = 4%

equivalent present worth = 3000/(4%-2%)*(1-(1.02/1.04)^5)

equivalent present worth = $13878.91 or $13879