Mr. Art Deco will be paid $230,000 one year hence. This is a nominal flow, which

Question

Mr. Art Deco will be paid $230,000 one year hence. This is a nominal flow, which he discounts at an 7% nominal discount rate: PV = 230,000 = $ 214,953 1.07 The inflation rate is 5%. Calculate the PV of Mr. Deco’s payment using the equivalent real cash flow and real discount rate. (You should get exactly the same answer as he did.) (Do not round intermediate calculations. Round your "Real cash flow" and "Present value" answers to the nearest dollar amount and "Real discount rate" answer to 2 decimal places.)

Real cash flow $

Real discount rate %

Present value $

Explanation / Answer

Given nominal discount rate=7%.

Nominal cash flow after one year=230,000.

Real cash flows = Nominal cash flows/(1+inflation rate)n

Where n = number of years.

=$230,000/1.05

=$219047.619

Real discount rate formula =Nominal rate - Inflation rate/(1+inflation rate)

Inflation rate= 5%

Real discount rate = 7% -5%/(1+0.5)

=0.02/1.05

=1.90476%

Present value with real cash flows and real discount rate =Real cash flows/(1+real discount rate)

=$219047.619/(1+.0190476)

=$214,953.27 rounded to $214,953

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