Question

6. You are planning to invest $2,500 today for three years at a nominal interest rate of 9 percent with annual compounding.

a. What would be the future value of your investment?

b. Now assume that inflation is expected to be 3 percent per year over the same three-year period. What would be the investment’s future value in terms of purchasing power?

c. What would be the investment’s future value in terms of purchasing power if inflation occurs at a 9 percent annual rate?

Answer 1

Given,

Investment = $2500

Interest rate = 9% or 0.09

No. of years (n) = 3 years

Solution :-

(a)

Future value = Investment x (1 + interest rate)ⁿ

= $2500 x (1 + 0.09)³

= $2500 x (1.09)³

= $2500 x 1.295029 = $ 3237.57

(b)

Inflation rate = 3% or 0.03

Future value in terms of purchasing power = Investment x (1 + inflation rate)ⁿ

= $2500 x (1 + 0.03)³

= $2500 x (1.03)³

= $2500 x 1.092727 = $2731.82

(c)

inflation rate = 9% or 0.09

Future value in terms of purchasing power = Investment x (1 + inflation rate)ⁿ

  = $2500 x (1 + 0.09)³

= $2500 x (1.09)³

= $2500 x 1.295029 = $3237.57