You need $25,000 in today\'s buying power, 5 years from novw You can earn 3% APR

Question

You need $25,000 in today's buying power, 5 years from novw You can earn 3% APR in real terms on your investments How much must you invest (a different amount each year), starting next year for 4 years to just meet your needs, if you expect inflation to be 4% per year? The amount you invest should just maintain the real cash values Year 1 Year 2 Year 3Year 4 $6,335 $6,589 $6,852 $7,126 Year 1 Year 2 Year 3Year 4 $6,034 $6,275 $6,526 $6,787 Year 1 Year 2 Year 3Year 4 $5,732 $5,961 $6,200 $6,448 Year 1 Year 2 Year 3Year 4 $6,456 $6,714 $6,983 $7,262

Explanation / Answer

Inflation rate = 4%

The value of $25000 in today's buying power will be 30416.32 after 5 years.

The formula to calculate the future value by using Excel function: FV(rate, nper, pmt, pv)

Rate: 4%

nper: 5 years

pmt: 0

PV: 25000

Real rate of return : 3%

Inflation rate : 4%

Nominal rate : (1+ real rate)*(1+ inflation) - 1

= 1.03*1.04 - 1 = 7.12%

After 1 year, the first investment become = 6034*(1+7.12%) = 6463.62

At the beginning of 2nd year the toal amount will be = 6463.62 + 6275 = 12738.62

At the end of 2nd year, the amount will be = 12738.62*(1+7.12%) = 13645.61

At the beginning of 3rd year. the amount will be = 13645.61 + 6526 = 20171.61

At the end of 3rd year, the amount will be = 20171.61*(1+7.12%) = 21607.83

At the beginning of 4th year, the amount will be = 21607.83 + 6787 = 28394.83

At the end of 4th year, the amount will be = 28394.83*(1 + 7.12%) = 30416.54

1 2 3 4 7.12% 7.12% 7.12% 7.12% 6034 6275 6526 6787

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