Caffeineland is a small country in Central America. The main product of the country is coffee, which is currently priced at $1.20 per cup. Inflation is expected to be 10% per year, and the nominal interest rate is 10% per year.

a) Calculate the real interest rate.

b) Suppose you want to borrow 1000 cups of coffee now and pay back the loan next year. How many cups of coffee would you owe? What is the interest rate for this coffee loan?

HINT: Borrow money now and use it to buy coffee at the current price. Then calculate how much you owe in dollars next year. Use next year's coffee price to determine how much you owed in terms of "cups of coffee."

c) Juan Valdez, a brilliant local scientist, has invented a coffee replicator. It works as follows: At time zero you insert 1000 cups of coffee. These cups are consumed by the machine - you have to 'invest' 1000 cups now to make the replicator work. The for the next 5 years, the replicator produces 300 cups of coffee per year. you get 300 cups at year 1, year 2 and so on. after five years the replicator is used up. CALCULATE THE PV OF THE REPLICATOR IN TERMS OF DOLLARS.

d) Now calculate the PV of the replcator in terms of coffee. HINT: Use cups of coffee as your currency. Make a coffee-flow diagram and then calculate rhe PV. Be sure to use the coffee interest rate in your PV calculations.

e) Convert the PV in terms of coffee from part d into dollars. Multiply the answer from part d by the current price of coffee.