Question

Your salary next year is expected to be $40,000. Assume you expect your salary to grow at a steady rate of 4% per year for another 21 years. If the appropriate cost of capital (aka discount rate) is 11%, what is the PV today of your future salary cash flow stream? For simplicity, assume the salary amounts are at the end of each of the next 21 years. Answer to zero (0) decimal places.

Answer 1

Given that,

expected next year salary = $40000

salary growth rate i = 4% for next 21 years

cost of capital n = 11%

So, real rate of interest adjusting inflation is

real rate = (1+n)/(1+i) - 1 = 1.11/1.04 - 1 = 6.73%

So, it can be assumed now that constant payment of PMT = ($40000/1.04) = $38461.54 at the end of every year for next 21 years.

Discount rate r = 6.73%

So, PV of this annuity is

PV = PMT*(1 - (1+r)^-t)/r = 38461.54*(1 - 1.0673^-21)/0.0673 = $425923

So, PV today of your future salary cash flow stream is $425923