Question

Problem 10.15 You are buying a sofa. You will pay $200 today and make three consecutive annual payments of $300 in the future. The real rate of return is 15.5 percent, and the expected inflation rate is 4 percent. What is the actual price of the sofa? (Round intermediate calculation and final answer to 2 decimal places, e.g. 15.25.) Actual price $

Answer 1

Answer:

$ 973.50

Step-by-step explanation:

You pay today : $200

For the next 3 years you pay $300 each.

Total payment combined for 3 years = 300(3) = $900

Total money Spent to buy sofa = 900 +200 = $1100

Real rate of return = 15.5%

Expected inflation rate over 3 years = 4 %

The Return amount = Real rate of return x Total Money Spent

The Return amount = 1100 x 15.5 % = $ 170.5

Inflation value = Total Money Spent x Inflation rate

Inflation value = 1100 x 4 % = $ 44

To find the actual cost, we must add the inflation value and subtract the return amount from Total money spent to buy the sofa

Actual cost =  Total money spent to buy + Inflation value - Return amount

Actual cost = 1100 + 44 - 170.5

Actual cost = $ 973.5