Fourteen years ago, the U.S. Aluminum Corporation borrowed $9.9 million. Since t

Question

Fourteen years ago, the U.S. Aluminum Corporation borrowed $9.9 million. Since then, cumulative inflation has been 98 percent (a compound rate of approximately 5 percent per year). a. When the firm repays the original $9.9 million loan this year, what will be the effective purchasing power of the $9.9 million? (Hint: Divide the loan amount by one plus cumulative inflation.) b. To maintain the original $9.9 million purchasing power, how much should the lender be repaid? (Hint: Multiply the loan amount by one plus cumulative inflation.) c. If the lender knows he will receive $9.9 million in payment after 14 years, how might he be compensated for the loss in purchasing power? A descriptive answer is acceptable

Explanation / Answer

U.S. Aluminum Corporation Loan amount $9,900,000 = = $5,000,000 a. 1 + Cumulative inflation 1.98 ======================================================================================= b. $9,900,000 1.98 = $19,602,000 A $19,602,000 loan repayment in a 98% cumulative inflationary environment will provide $9,000,000 in purchasing power to the original lender. =========================================================================== c. Charge a high enough interest rate to not only provide an adequate annual return on the borrowed funds, but also compensate for the loss of purchasing powe

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