468 INFLATION AND PRICECHANGE- I
the end of 3 years, Sam sold the house for $205,000.
After paying off the two loans and the real estate
broker, he had $40,365 left. After taking an 8% in-
flation rate into account, what was his before-tax rate
of return?
14-28 General price inflation is estimated to be 3% for
the next 5 years, 5% the 5 years after that, and 8%
the following 5 years. If you invest $10,000 at 10%
for those 15 years, what is the future worth of your
investment in terms of actual dollars at that time and
in terms of real base-zero dollars at that time?
14-29 Ima Luckygirl recently found out that her grand-
father has passed away and left her his Rocky
Mountain Gold savings account. The account was
originally opened 50 years ago when Ima's grand-
father deposited $2500. He had not added to or sub-
tracted from the account since then. If the account has
earned an average rate of 10% per year and inflation
has been 4% per year, answer the following:
(a)How much money "is currently in the account in
actual dollars?
(b)Express the answer to part (a)in terms of the
purchasing power of dollars from 50 years ago.14-30 Auntie Frannie wants to provide tuition for her twin
nephews to attend a private school. She-anticipates
sending a check for $2000 at the end of each of the
next 8 years to apply to the cost of schooling.
(a) If general price inflation, as well as tuition price
inflation, is expected to average 5% per year for
those 8 years, calculate the present worth of the
gifts. Assume that the real interest rate will be
3% per year.
(b)If Auntie Frannie wants her gifts to keep pace
with inflation, what would be the present worth
of her gifts? Again assume inflation is 5% and
the real interest rate is 3%.
14-31 As a recent graduate, you are considering employ-
ment offers from three different companies. However,
in an effort to confuse you and perhaps make their
offers seem better, each company has used a different
purchasing power basefor expressing your annual
salary over the next 5 years. If you anticipate inflation
to be 6% for the next 5 years and your personal (real)
MARR is 8%, which plan would you choose?
Company A: A constant $50,000 per yefU"in
terms of today's purchasing power.
Company B: $45,000 the first year, with
increases of $2500 per year thereafter.
---Company C: A constant $65,000 per year in
terms of Year-5-based purchasing power.
14-32 Calculate the future equivalent in Year 15 of:
(a) Dollars having today's purchasing power.
(b) Then-current purchasing power dollars, of
$10,000 today. Use a market interest rate of
15% and an inflation rate of 8%.
14-33 A firm is having a large piece of equipment over-
hauled. It anticipates that the machine will be needed
for the next 12 years. The firm has an 8% minimum
attractive rate of return. The contractor has suggested
three alternatives:
(a)A complete overhaul for $6000 that should permit
12 years of operation.
(b)A major overhaul for $4500 that can be expected
to provide 8 years of service. At the end of 8 years,
a minor overhaul would be needed.
(c) A minor overhaul now. At the end of 4 arid 8 years,
additional minor overhauls would be needed.
If minor overhauls cost $2500, which alternative
should the firm select? If minor overhauls, which
now cost $2500, increase in cost at +5% per year,
but other costs remain unchanged, which alte~ative
should the firm select? (Answers:Alt.(c);Alt.(a»
14-34 A couple in Ruston, Louisiana, must decide whether
it is more economical to buy a home or to continue
to rent during an inflationary period. Presently the
couple rents a one-bedroom duplex for $450 a month
plus $139 a month in basic utilities (heating and
cooling). These costs tend to increase with inflation,
and with the projected inflation rate of 5%, the cou-
ple's monthly costs per year over a 1O-year planning
horizon are as follows.n= 1. 2 3 4 5 6 7 8 9 10
Rent 450 473 496 521 547 574.~ 603 633 665 698
Utilities 139 146 153 161 169 177 186 196 205 216The couple would like to live on the north side of the
town, where an average home of 150 m2 of heating
area costs $75,000. A local mortgage company will
provide a loan for the property provided the couple
makes a down payment of 5% plus estimated closing
costs of 1% cash for the home. The couple prefers
a 30-year fixed-rate mortgage with an 8% interest
rate. Based on the couple's gross annual income, the
couple falls in the 30% marginal income tax rate
(federal plus state), and as such, buying a home will
provide them some tax write-off. It is also estimated
that the basic utilities for the home inflating at 5%--- --