Question

A university graduate earns a starting salary of $40,000 per year, and expects to receive a 6% increase in salary in each of the next 5 years. If the inflation rate is 2.5%, what will be her real income in terms of today’s dollars at the end of five years?

Answer 1

Annual Raise= 6% or   0.06
Inflation rate= 2.5% or   0.025
Real rate =((1+Nominal rate)/(1+ inflation rate))-1  
((1+0.06)/(1+0.025))-1  
0.03414634146  
So, real interest rate (r)=   0.03414634146
Time (n)= years   5
present value =   40000
Future value formula = present value*(1+r)^n  
40000*(1+0.03414634146)^5  
47311.85658  
So, real income in terms of today's dollars at end of five years=   $47,311.86