Question

You just signed a business consulting contract with one of your clients. The client will pay you $50,000 a year for five years for the service you will provide over this period. You anticipate the general inflation rate over this period to be 6%. If your desired inflation-free interest rate (real interest rate) is to be 4%, what is the worth of the fifth payment in present dollars? The client will pay the consulting fee at the end of each year.

Answer 1

Answer:

$31,046

Explanation:

real interest rate = nominal interest rate - inflation

4% = nominal interest rate - 6% ⇒ nominal interest rate = 10%

if you want to determine the present value of the fifth payment, and you require a 4% real interest rate, the you must use a discount value = nominal interest rate

present value = payment / (1 + rate)⁵ = $50,000 / (1 + 10%)⁵ = $50,000 / 1.1⁵ = $50,000 / 1.61051‬ = $31,046