Question

Twenty years ago, the Archer Corporation borrowed $7,550,000. Since then, cumulative inflation has been 81 percent (a compound rate of approximately 3 percent per year).

a. When the firm repays the original $7,550,000 loan this year, what will be the effective purchasing power of the $7,550,000? (Hint: Divide the loan amount by one plus cumulative inflation.) (Do not round intermediate calculations and round your answer to the nearest whole dollar.)

b. To maintain the original $7,550,000 purchasing power, how much should the lender be repaid? (Hint: Multiply the loan amount by one plus cumulative inflation.) (Do not round intermediate calculations and round your answer to the nearest whole dollar.)

  

Answer 1

a) $7,550,000 was borrowed twenty years ago. It had a purchasing power of $7,550,000, 20 years ago. But, due to inflation, this purchasing power will reduce each year. Since, we are already given cumulative inflation, i.e., cumulative decrease in purchasing power -

Effective purchasing power of original loan = $7,550,000 / (1 + Cumulative inflation) = $7,550,000 / (1 + 0.81) = $4,171,270.71823 or $4,171,271

b) Since the purchasing has reduced, we would require more dollars in comparison to earlier years -

Amount to be repaid = $7,550,000 x (1 + Cumulative inflation) = $7,550,000 x (1 + 0.81) = $13,665,500