Your firm recently lent Arlington Enterprises $22,440,000 million for one year a

Question

Your firm recently lent Arlington Enterprises $22,440,000 million for one year at an interest rate of 12.00%. Inflation during the year is expected to be 3.80%.

Answer the following questions to gauge the impact of inflation on the real interest to be paid. (Round all answers to 2 decimal places.)

a. How much interest income will your firm receive from the transaction, calculated the traditional way? Interest income $

b. What is the approximate real rate of interest? Approximate real rate of interest %

c. What is the real portion of the interest income? Real portion of interest income $

d. By how much will interest income be understated due to inflation? Understated interest $

Explanation / Answer

a.) Amount Lent =$22,440,000

Interest Rate =12%

Time =1 year

Interest Income =$22,440,000 x 0.12 x 1 =$2,692,800

b.) Real Rate of Interest = Nominal Rate - Inflation = 12% - 3.80% =8.20%

c.) Real portion of Interest Income = 0.082 x 22,440,000 x 1 =$1,840,080

d.) Understated Interest Income =$ 2,692,800 - 1,840,000 =$852,800

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