A business owner would like to save up $250,000 (in today’s dollars) to construc

Question

A business owner would like to save up $250,000 (in today’s dollars) to construct a new addition to its office building in 15 years. The inflation rate is expected to be 6% per year over the 15 year period. The business owner will place money into an investment account now (time 0) in order to pay for the addition. The investment account will earn 10% interest per year. How much money should be set aside now (time 0) in an investment account inorder to have $250,000 15 years from now to pay for the addition?

Explanation / Answer

Solution :- Calculation of money to be kept in investment account today :-

= 250000 / (1 + 0.04)15 (Real interest rate = 10 % - 6 % = 4 % or 0.04)

= 250000 / (1.04)15

= 250000 / 1.80

= $ 138888.89 (approx).

Conclusion :- Money to be kept in investment account today = $ 138888.89 (approx).

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