FE PROBLEM 10.1
ANSWER: d
SINCE THE CASH FLOW IS IN THEN-CURRENT DOLLARS, A COMBINED DISCOUNT RATE MUST BE USED.
FE PROBLEM 10.2
ANSWER:
c
SINCE EACH SUBSEQUENT CASH FLOW IS 6% GREATER THAN THE PREVIOUS CASH FLOW, IT IS A GEOMETRIC SERIES.
FE PROBLEM 10.3
ANSWER: a
CONSTANT DOLLARS DO NOT INCLUDE INFLATION. THE CASH FLOWS WILL BE A UNIFORM SERIES OF $600/YEAR.
FE PROBLEM 10.4
ANSWER: d
IN 10 YEARS, THE SELLING PRICE WILL EQUAL $10(1.07)10, OR $19.67
FE PROBLEM 10.5
ANSWER: b
SINCE THEN-CURRENT DOLLARS ARE USED, A COMBINED RATE IS REQUIRED:
7% + 10% + 7%(10%) = 17.7%
FE PROBLEM 10.6
ANSWER: c
SINCE THE CASH FLOWS ARE IN CONSTANT DOLLARS, A REAL RATE (ONE THAT DOES NOT
INCLUDE INFLATION) IS TO BE USED.
FE PROBLEM 10.7
ANSWER: a
THEY WILL BE THE SAME, IF PERFORMED CORRECTLY.
FE PROBLEM 10.8
d. $456,200
rationale: SALE PRICE = $100,000 (1.03)^10 (1.13)^10 = $456,201.47
PROBLEM 10.1
SOME GOOD DEFINITIONS OF INFLATION ARE:
PERSISTENT DECREASE IN THE PURCHASING POWER OF MONEY
PERSISTENT INCREASE IN THE LEVEL OF PRICES WITHOUT INCREASING VALUE
EROSION IN THE PURCHASING POWER OF MONEY
SUSTAINED INCREASES IN THE PRICES OF GOODS AND SERVICES
PROBLEM 10.2
EXAMPLES OF GOODS OR SERVICES EXHIBITING INFLATION INCLUDE:
PRICE OF GASOLINE
COST OF HOUSING / REAL ESTATE (GEOGRAPHICALLY DEPENDENT – CAN ALSO DEFLATE)
PRICE OF COPPER
PRICE OF TEXTBOOKS
COST OF TUITION
COST PER HOUR OF MECHANIC WORK
PROBLEM 10.3
DEFLATION MAY BE EXPRESSED AS A NEGATIVE INFLATION
AN EXCELLENT EXAMPLE OF SOMETHING THAT HAS EXHIBITED DEFLATION IS
MOST ALL ELECTRONICS EQUIPMENT, INCLUDING TELEVISIONS, COMPUTERS, GAMES, PHONES
DEFLATION MAY BE EASIER TO SEE OVER THE LONG HAUL
FOR EXAMPLE, A REGULAR 19″ COLOR TV COST ABOUT $450 IN 1969.
TODAY, ONE CAN BUY A BETTER REGULAR 19″ COLOR (NO OTHER CHOICE!) TV EASILY FOR LESS THAN $150
PROBLEM 10.4
IN RECENT YEARS, WE HAVE SEEN THE PRICE OF REAL ESTATE (HOMES, APARTMENTS, OFFICES, AND LAND) INCREASE.
THEN, BEGINNING IN 2006, THE SAME THINGS HAVE BEGUN TO DECREASE DRAMATICALLY IN PRICE.
INTERESTINGLY, WE HAVE SEEN BOTH HAPPEN AT THE SAME TIME. FOR EXAMPLE, RECENT DEFLATION ON THE
EAST AND WEST COASTS OF THE USA, WITH CONTINUED INFLATION IN THE MIDDLE OF THE COUNTRY.
PROBLEM 10.5
THE CPI IS A MARKET BASKET RATE IN THAT IT IS BASED ON 80,000 PRICES THAT ARE RECORDED IN
87 URBAN AREAS. THE “MARKET BASKET” IS PURCHASED EACH MONTH AND REFLECTS WHAT
COUSUMERS PURCHASE FOR THEIR DAY TO DAY LIVING.
PROBLEM 10.6
THE CONSUMER PRICE INDEX (CPI) MEASURES PRICE CHANGES FROM THE PERSPECTIVE OF THE PURCHASER.
THE PRODUCERS PRICE INDEX (PPI) MEASURES PRICE CHANGES FROM THE PERSPECTIVE OF THE SELLER.
THE PPI IS A FAMILY OF OVER 10,000 INDEXES PUBLISHED MONTHLY BY THE BLS, AND THERE IS AN INDEX
FOR PRACTICALLY ANY BUSINESS.
PROBLEM 10.7
THE HIGHER EDUCATION PRICE INDEX (HEPI) MEASURES THE AVERAGE RELATIVE LEVEL IN THE PRICES OF
A FIXED MARKET BASKET OF GOODS AND SERVICES PURCHASED BY COLLEGES AND UNIVERSITIES,
EXCLUDING EXPENDITURES FOR RESEARCH. IT INCLUDES SALARIES, WAGES, AND FRINGE BENEFITS,
CONTRACTED SERVICES (DATA PROCESSING, COMMUNICATIONS, TRANSPORTATION, SUPPLIES, ETC.).
THERE ARE OVER 100 ITEMS PRICED IN THE HEPI.
THE HEPI IS SIMILAR TO THE CPI AND PPI; HOWEVER, THEY ARE FOCUSED ON CONSUMERS AND PRODUCERS,
RESPECTIVELY. THE HEPI IS FOCUSED STRICTLY ON HIGHER EDUCATION.
HEPI AND CPI ARE RELATED IN THAT THE CPI INCLUDES COLLEGE TUITION IN ONE OF ITS CATEGORIES.
THE CPI IS VIEWING THE COST OF HIGHER EDUCATION FROM THE VIEWPOINT OF THE STUDENT. THE
HEPI IS VIEWING THE COST OF HIGHER EDUCATION FROM THE PERSPECTIVE OF THE COLLEGE OR
UNIVERSITY.
PROBLEM 10.8
THEY SHOULD NOT CONCLUDE THAT THE CPI IS IRRELEVANT TO THEM. THEY NEED TO REALIZE TWO
THINGS, IN PARTICULAR. FIRST, THE CPI DOES NOT “EXACTLY” DESCRIBE ANY INDIVIDUAL’S PURCHASING
HABITS. SECOND, THE ECONOMY TODAY IS VERY “CONNECTED” IN THAT PRICE FLUCTUATIONS IN CERTAIN
ITEMS A CONSUMER DOES NOT PURCHASE DO AFFECT PRICE FLUCTUATIONS IN THINGS THEY DO
PURCHASE. FOR EXAMPLE, LEATHER SHOES ARE AFFECTED BY THE PRICE OF ANIMALS FROM WHICH
THE LEATHER COMES. THE PRICE OF ANIMALS IS AFFECTED BY THE QUALITY OF THE ANIMALS AS
DETERMINED BY WHAT THEY ARE FED AND THE CARE THEY RECEIVE. FEED PRICES FOR THE ANIMALS
(INCLUDING PROCESSED FOODS OR NATURAL GRASS) ARE AFFECTED BY ENERGY USED IN PROCESSING
OF FEED OR FERTILIZER. THE PRICE OF ENERGY USED IS AFFECTED BY OIL AND GAS PRICES. AND SO ON.
THE BOTTOM LINE IS THAT THE CPI DOES A PRETTY GOOD JOB OF ESTIMATING OVERAL PRICE INCREASES
TO CONSUMERS, AND IT IS NOT IRRELEVANT SIMPLY BECAUSE ONE’S BUYING HABITS ARE NOT EXACTLY
REFLECTED BY THE MARKET BASKET.
PROBLEM 10.9
a
YEAR 2002 2003 2004 2005 2006
INDEX 179.9 184.0 188.9 195.3 201.6
INFLATION RATE 2.28% 2.66% 3.39% 3.23%
b ((1+f)^4)-1 = ((INDEX2006 – INDEX2002)/INDEX2002)
(INDEX2006-INDEX2002)/INDEX2002= 12.06226%
((1+f)^4)-1 = 12.06226% SOLVER TARGET CELL
f= 2.88803% SOLVER CHANGED CELL
PROBLEM 10.10
a
YEAR 2000 2001 2002 2003 2004 2005
RATE 1.6% 2.4% 1.9% 3.3% 3.4%
INDEX 100.0 101.6 104.0 106.0 109.5 113.2
b ((1+f)^5)-1 = ((INDEX2005 – INDEX2000)/INDEX2000)
(INDEX2005-INDEX2000)/INDEX2000= 13.23709%
((1+f)^5)-1 = 13.23711% SOLVER TARGET CELL
f= 2.51744% SOLVER CHANGED CELL
PROBLEM 10.11
a YEAR 2001 2002 2003 2004 2005
INDEX 214.8 235.8 252.2 281.2 305.1
INCREASE RATE 9.78% 6.96% 11.50% 8.50%
b ((1+f)^4)-1 = ((INDEX2005 – INDEX2001)/INDEX2001)
(INDEX2005-INDEX2001)/INDEX2001= 42.03911%
((1+f)^4)-1 = 42.03913% SOLVER TARGET CELL
f= 9.16967% SOLVER CHANGED CELL