Deck 9: Inflation

Question 1

Mary graduated from a college in 2004 and she wanted to go on a sea cruise the same year. However, she could not afford it at that time because of the high price of $2 550. Today she can afford it, however, the cruise price is $2 870 now. If the price of the cruise in real dollars has not changed and the inflation rate has been 3.0% since 2004, what year is it now?

A)2007
B)2008
C)2009
D)2010
E)2011

Answer 1

B

Question 2

How should engineers deal with the fact that inflation rates are very difficult to predict?

A)Avoid any projects that involve cash flows occurring more than two years in the future.
B)Obtain estimates of inflation from expert economists.
C)Assume that inflation rates will average out to zero over the project life.
D)Base project analysis on the highest rates of inflation that have occurred in the last ten years.
E)Perform a sensitivity analysis on the profitability of the project for different inflation rates.

Answer 2

E

Question 3

If Tonya as a municipal engineer evaluates a project which is subject to the effect of inflation, she should

A)work with nominal values for cash flows and nominal interest rates.
B)work with real values for cash flows and nominal interest rates.
C)work with nominal values for cash flows and real interest rates.
D)work with constant values for cash flows and current interest rates.
E)rely on forecast of future interest rates and cash flows in real or nominal terms.

Answer 3

A

Question 4

A municipality issued bonds to finance its infrastructure projects. The bonds pay 6.5% per year. If expected annual inflation is 3.5%, what is the real rate of return on these bonds?

A)2.90%
B)3.00%
C)3.50%
D)6.50%
E)10.23%

Question 5

If Trevor uses the real MARR and determines cash flows in actual dollars then he

A)cannot estimate the profitability of investments.
B)estimates the profitability of investments incorrectly.
C)estimates the profitability of investments correctly.
D)overestimates the profitability of investments.
E)underestimates the profitability of investments.

Question 6

Suppose that the CPI was 105 on Jan 1, 2008 and 117 on Jan 1, 2011. What was the average annual inflation over the intervening period?

A)4.00%
B)3.97%
C)3.87%
D)3.77%
E)3.67%

Question 7

A valuable asset was priced at $1 million in 1995. What should be its nominal price in 2012 if the CPI was 95 in 1995 and 145 in 2012?

A)$0.95 million
B)$1.25 million
C)$1.45 million
D)$1.53 million
E)$1.65 million

Question 8

A typical consumption basket for 2010 and 2011 is as follows: Suppose that 2010 is the base year. What is the CPI for 2011?

A)93.6
B)106.8
C)107.9
D)108.2
E)111.3

Question 9

The highest level of inflation in Canada in the post World War II period was observed in the

A)1950s.
B)1960s.
C)1970s.
D)1980s.
E)1990s.

Question 10

Data from the International Monetary Fund are as follows: where CPI = Consumer Price Index INF = Inflation Rate
UEM = Unemployment Rate
What is the base year in this case?

A)1984
B)1985
C)1995
D)1990
E)1998

Question 11

A municipality decided to invest $500 000 in a four-year project. To decide whether the project should be undertaken, a city engineer was asked to run a financial analysis. Carrying out the analysis in actual dollars, the engineer found that by its very end the project would just break even. If inflation is expected to be 4.0% per year, what is the real IRR?

A)-3.8%
B)-4.0%
C)-4.2%
D)-4.4%
E)-4.6%

Question 12

The equation that converts actual dollars into real dollars can be written in terms of

A)the present worth compound interest factor.
B)the series present worth factor.
C)the compound amount factor.
D)the capital recovery factor.
E)the capitalized value.

Question 13

Jason inherited $6 000 from his grandfather. He decided to invest the money in a two-year project that promised a return of $2 000 by the end of this year and $4 500 at the end of the next year. Jason read an analytical report that inflation is going to be 3.0% over the next 5 years. He decided that he would only invest in this project if it could give him at least 10% real rate of return. What is the present worth of his investment under this rate of return?

A)$183
B)-$873
C)-$462
D)-$729
E)$5 289

Question 14

A company invested $3.5 million in a five-year project. It assessed that this project would generate $4.4 million revenue by the end of a five-year period in terms of today's dollars. If inflation is expected to be 3.0% per year over that period, what is the current IRR?

A)4.7%
B)5.7%
C)6.8%
D)7.8%
E)8.7%

Question 15

A municipality issued bonds to finance its infrastructure projects. The bonds are supposed to pay 6.5% per year. A city engineer calculated the real rate of interest to be 3.5% next year. What inflation rate did the engineer assume?

A)2.7%
B)2.9%
C)4.8%
D)9.2%
E)22.2%

Question 16

The cost of one of the following products has changed very differently from the others over time. Which is the odd one out?

A)food
B)clothing
C)computers
D)oil
E)housing

Question 17

The price of a TV set was $600 in 1999. In 2003 it was priced at $520. If the CPI in 1999 was 123 and 2003 is the base year, has the TV set become cheaper or more expensive in real terms in 2003?

A)Real-dollar cost of the TV set has not changed.
B)Real-dollar cost of the TV set has increased by 6.6%.
C)Real-dollar cost of the TV set has decreased by 6.6%.
D)Real-dollar cost of the TV set has decreased by 15.8%.
E)Real-dollar cost of the TV set has increased by 15.8%.

Question 18

In general, inflation is defined as

A)the increase in Gross Domestic Product over time.
B)a measure of the average person's preference for a present good compared to a future good.
C)an increase in prices of goods and services that are included in a consumption basket over time.
D)an increase in the purchasing power of money over time.
E)the difference between the real and nominal Gross Domestic Product (GDP).

Question 19

What should be done when the price of one good or service changes differently from the average price of other goods and services associated with a project?

A)Incorporate the price change directly into the cash flows of the project.
B)Incorporate the price change into the real MARR of the project.
C)Assume that the price change is the same for all goods and services of the project.
D)Use two different MARRs for different goods and services of the project.
E)Find the average price change for all goods and services of the project.

Question 20

The real MARR can be defined as

A)the real interest rate minus an adjustment that reflects the inflation effect.
B)the actual interest rate plus an adjustment that reflects the inflation effect.
C)the real interest rate plus an adjustment that reflects the inflation effect.
D)the actual MARR plus an adjustment that reflects the inflation effect.
E)the actual MARR minus an adjustment that reflects the inflation effect.

Question 21

Jagdeep is considering a project that requires a large immediate investment and yields a return in five years. If he assumes that there will be be no inflation over the next five years, his calculated rate of return on the project is 25%. If he instead assumes a 10% annual rate of inflation, what will his expected real rate of return be?

A)It will still be 25%.
B)13.64%
C)15%
D)35%
E)37.5%

Question 22

I am considering a project which requires an immediate investment of $10 000 and yields a return in two years. If I expect the rate of inflation to be 15%, how big, in actual dollars, must the return be if my real rate of return on the project is to be 20%?

A)$13 500
B)$13 800
C)$14 400
D)$18 225
E)$19 044

Question 23

Heather deposits $8 000 in an investment account that offers 5% interest per year. The interest is due in 5 years. Annual inflation is expected to be 4% over the next 5 years. Heather's actual MARR per six-month period is 5%, compounded semiannually. What is the present worth of the interest?

A)$1 357
B)$1 471
C)$1 492
D)$1 504
E)$1 541

Question 24

The inflation rate is 10%. A project will yield $1 000 in real dollars at the end of two years. How many actual dollars will it yield?

A)$900
B)$909
C)$1 100
D)$1 110
E)can't tell unless we know the MARR

Question 25

If the CPI was 99.6% in January 2001 and 128% in January 2005, what was the approximate annual inflation over the intervening period?

A)28.4%
B)7.1%
C)6.4%
D)5.0%
E)0.4%

Question 26

Suppose that you need to accumulate $10 000 in three years in today's dollars. What monthly amount in nominal (actual)dollars should you save if your real rate of return is 5% and expected annual inflation rate is 3%?

A)$246.14
B)$258.04
C)$268.96
D)$275.14
E)$281.96

Question 27

Suppose John deposits some money in an investment account that offers 5% interest rate per year. Annual inflation is expected to be 3.5% over the next 5 years. What is the inflation rate per half a year?

A)1.50%
B)1.73%
C)1.75%
D)1.78%
E)1.80%

Question 28

Annual inflation is expected to be 3.5% over the next 5 years. Heather's real MARR is 6%, compounded semiannually. What is the effective actual MARR per half a year?

A)4.78%
B)5.67%
C)7.12%
D)8.26%
E)9.71%

Question 29

A bank offers me 10% annual interest on an investment, but the inflation rate is 5%. What is the real interest rate?

A)2%
B)4.76%
C)5%
D)15%
E)15.5%

Question 30

I invested a sum of money in a project five years ago. The rate of inflation since then has been 5% per year. Now I receive a return of $5 000 on my original investment. I calculate that my real rate of return on the original investment has been 10%. What was the size of my original investment?

A)$2 435
B)$3 105
C)$3 918
D)$3 962
E)$6 309

Question 31

A bank offers me 10% annual interest on an investment, but the inflation rate is 5%. If I invest $500 in the bank, what will the value of my investment be, in real dollars, in five years time?

A)$396
B)$631
C)$638
D)$805
E)$1 028

Question 32

A project involves a substantial expenditure right now, and is expected to yield a return of $X ten years in the future. We expect the annual inflation rate to be positive over the next ten years. Four analysts calculate the present worth of the project. Alice bases her calculation on the assumption that X is given in real dollars, using a real MARR. Bob also assumes that X is in real dollars, but uses the actual MARR to calculate present worth. Cecil assumes that X is in actual dollars, and calculates present worth using the real MARR. Donna also assumes that X is in actual dollars, and calculates present worth using the actual MARR. Who comes up with the highest figure for present worth?

A)Alice
B)Bob
C)Cecil
D)Donna
E)They will all come up with the same figure.

Question 33

It is known that the inflation rate over next three years is expected to be 5% in the first year, 10% in the second and 15% in the third. In such a case, average expected annual inflation rate is

A)5.00%.
B)9.92%.
C)10.00%.
D)10.08%.
E)15.00%.

Question 34

A four-year project requires $1 000 000 as the first cost and brings $2 000 000 at the end of the fourth year. If expected annual inflation over this period is 5%, what is the real IRR of this project?

A)13.3%
B)18.9%
C)27.6%
D)47.6%
E)95.0%

Question 35

I am promised a payment of $250 a year from now, repeating every year for a total of ten years. I can invest money at 10% interest, but the inflation rate over the next ten years is expected to be 5%. What is the smallest amount of money you could offer me right now that would persuade me to give up these payments?

A)250(P/A,0.05,10)
B)250(P/A,0.15,10)
C)250(A/P,0.1,10)
D)250(P/A,0.155,10)
E)250(P/A,0.165,10)

Question 36

An engineering project requires $20 000 as first cost and has a planning horizon of five years. Operating costs are $2 000 per year, and expected annual revenue is $8 000. Calculate the project's present worth if the real interest rate is 5%, the expected annual inflation is 2% and the salvage value is $5 000.

Question 37

XWave Ltd. has spent $150 000 for the retraining of its personnel this year, and decided to repeat the retraining every third year. How much will this retraining cost next time if annual inflation is going to be 4% over the next five years?

A)$162 450
B)$168 730
C)$169 780
D)$171 216
E)$174 549

Question 38

Suppose that the CPI was 87.5% in 2000 and 132.2% in 2009. What is the value of $50 000 in 2009 in terms of 2000 dollars?

A)$66 100
B)57 143
C)$43 750
D)$37 821
E)$33 094

Question 39

John's annual income in 2002 was $52 000. Now in 2011 John earns $63 000 per year. The CPI was 96 in 2002 and is 115 now. In real terms, is John better off now than he was in 2002?

Question 40

You want to invest $ 1 000 in a mutual fund that offers a 5% guaranteed rate of return. Current interest rate is 2%, and inflation is expected to be 1% per year. How much will you accumulate in your account in 5 years in terms of today's dollars?

Question 41

Suppose that an economy is producing only two goods-a consumption good C and an investment good I. Using the following data:
Calculate the CPI in 2000 and 2004 with 1990 as the base year.

Question 42

How does inflation affect the evaluation of engineering projects?

Question 43

The purchase of a car requires a $25 000 loan to be repaid in monthly installments for four years at 12% annual real interest rate. If annual inflation rate is 4%, find the amount paid, in actual dollars, in the 20th month.

Question 44

A 10-year project is evaluated under two scenarios: (i)with inflation, and (ii)without inflation. Without inflation, and with a 10% interest rate, its present worth is $24 254. If annual inflation of 2% is assumed, then the project's present worth becomes 20% lower. It is also known that the project's first cost involves the purchase of a capital asset which depreciates at 13% and will be sold for salvage at the end of the project, there are no operating costs, and there is a fixed annual revenue. What is the project's first cost?

Question 45

Explain how Statistics Canada calculates the inflation rate.

Question 46

How is the consumer price index calculated and what does it show?

Question 47

The price of oil is rising at 10% per year while inflation is just 2.5% per year. If the current price of oil is $45 per barrel, what would be the price of oil ten years from now in real dollars?

Question 48

John borrowed $5 000 from a commercial bank for 4 years to pay his tuition fee. Calculate the interest owed on this loan after 4 years in real dollars if the bank charges 5% annual (actual)interest rate and annual inflation is 2%.

Question 49

A painting cost $1 million in 1980. Now in 2011 its price is $5 million. Assuming average annual inflation of 4% over this period, has the painting increased/decreased in value and by how much?

Question 50

Explain the difference between an increase in average price level and an increase in relative prices in economic evaluation of engineering projects.

Question 51

ROVNO Ltd. just invested $50 000 into a new local network. Services provided by the network will bring $15 000 per year in the next five years. The following information is given:
- real MARR = 10%
- expected annual inflation = 2%
- the network will be sold for salvage after five years; its depreciation rate is 20%
Is this a good investment in terms of the internal rate of return?

Question 52

Canada's government savings bonds pay 3% annual real rate of return compounded daily. Professor John Jones invests $40 bi-weekly as a part of his University payroll program. If the inflation rate is assumed to be 2% per year over the next 10 years, what is the purchasing power of the professor's bonds 10 years from now?