A series of four annual constant-dollar payments beginning with $50,000 at the e

Question

A series of four annual constant-dollar payments beginning with $50,000 at the end of the first year is growing at the rate of 8% per year. Assume that the base year is the current year (n = 0). If the market interest rate is 16% per year and the general inflation rate (f) is 10% per year, find the present worth of this series of payments, based on (a)constant-dollar analysis. (b)actual-dollar analysis. Consider a situation, where (a) the equal-payment cash flow of $1,500 in constant dollars over three years is converted from the (b) equal-payment cash flow in actual dollars over three years, at an annual general inflation rate of f= 4%. Also, i = 8.5%. What is the amount A in actual dollars equivalent A' = $1,500 in constant dollars?

Explanation / Answer

Constant Dollar Analysis:

Considering annual payment of $50000, growth rate of 8%, below is the table for constant dollar analysis. Please note that in constant dollar inflation is not taken into account.

Using market interest rate of 16% and above cash flow,

Present worth in constant dollar analysis (using NPV formula of excel) =

Actual Dollar Analysis

Considering annual payment of $50000, growth rate of 8%, inflation of 10% below is the table for actual dollar cash flow

Using market interest rate of 16% and above cash flow,

Present worth in actual dollar analysis (using NPV formula of excel) =

Year Annual payment Growth rate Cash flow in constant Dollar 0 0 1 50000 1.08 54000 2 50000 1.08^2 58320 3 50000 1.08^3 62986 4 50000 1.08^4 68024

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