Question

You would like to have the current equivalent in terms of today's buying power of $2,500 in 10 years. How much would you have to invest today (in nominal terms) to fund this level of real consumption?

You expect inflation to be 5% per year over that time period. Your investments earn 7% per year in nominal terms.

A. $2,112
B. $2,500
C. $1,271
D. $2,070

Answer 1

D. $2,070

Step-by-step explanation:

First, convert $2500 real dollar amount at year 10 to to nominal amount;

If inflation rate is 5% per year, then in 10 years the inflation will compound to the following;

1.05^ 10 = 1.6289

Therefore, the nominal amount of your savings would be

= $2500*1.6289

= $4,072.25

Next, that would be your future value( FV), find its present value using the 7% as the discount rate. On a financial calculator, input the following;

FV = 4,072.25

I/Y = 7%

N= 10

PMT = 0

then compute present value ; CPT PV = $2,070