Question

Assume the real rate of interest is 4.00% and the inflation rate is 3.00%. What is the value today of receiving 12,408.00 in 15.00 years?

Answer 1

Nominal rate of interest = Real rate + Inflation rate = 4% + 3% = 7%

Value of investment after 15 years is 12408. The value today can be calculated as the present value of 12408

= 12408 / (1 + 7%)^15

= 4497.23

There is another way to calculate nominal rate of interest (multiplicative way)

= (1 + 4%) * (1 + 3%) - 1 = 7.12%

Using 7.12% instead of 7% we can again calculate the present value of the investment

= 12408 / (1 + 7.12%)^15

= 4422.25

Both the ways are correct and it depends which type of answer your instructor prefers.