Question

inflation and NPV

a)if the inflation rate was 4.5% and the rate of the interest is 5% in 2011, what was the nominal rate of interest for 2011?

b)You own a lease that will cost you $10,000 this year, increasing at 4.5% a year (the forecasted inflation rate) for 3 additional years (with four payments in total). The lease payment will be made in the beginning of the years. If the real rates are 5%, what is the present value cost

Answer 1

(a)

(1 + NR) = (1 + RR) (1+IR)

NR =NOMINAL RATE, RR=REAL RATE, IR = INFLATION RATE

(1 + NR) = (1 +0.05)(1+0.045) = 1.09725

NR = 9,725 %

(b)

As we calculated above nominal rate = 9.725%

so we will discount all payments by nominal rate

year	payments	pv factor @9.725%	pv of payment
0	10000	1	10000
1	10000(1+0.045) = 10450	0.9114	9524.13
2	10450(1+0.045) =10920.25	0.8306	9070.36
3	10920.25(1+0.045) =11411.66	0.7570	8638.63
	present value of all payments =		37233.12

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