Burrows Publishing has purchased the rights to the next book of famed romantic novelist Barbara Musk. Still unwritten, the book should be available to the public in four years. Currently, romantic novels sell for $10 in softcover. The publishers believe that inflation will be 6 percent a year over the next four years. Because romantic novels are so popular, the publishers anticipate that their prices will rise about 2 percent per year more than the inflation rate over the next four years. Burrows Publishing plans to sell the novel at $13.60 ( = 1.08 4 × $10 ) four years from now, anticipating sales of 100,000 copies.

The expected cash flow in the fourth year of $1.36 million ( = $13.60 × 100,000 ) is a nominal cash flow. That is, the firm expects to receive $1.36 million at that time. In other words, a nominal cash flow refers to the actual dollars to be received in the future.

The purchasing power of $1.36 million in four years is:

The figure of $1.078 million is a real cash flow because it is expressed in terms of purchasing power. Extending our hamburger example, the $1.36 million to be received in four years will only buy 1.078 million hamburgers because the price of a hamburger will rise from $1 to $1.26 ( = $1 × 1.06 ⁴ ) over the period.

Transcribed Image Text:

$1,077,635 = $1,360,489 1.064