Recall the future value annuity problems in which your goal is to have accumulated a certain amount in your account by a specified time in the future. For all parts of this problem we will expect the investment account to earn 6% interest and inflation to be 2.7%.

a) Now consider the effect of inflation; suppose that your goal is to accumulate a sum of money whose purchasing power in 5 years is equivalent to that of $200,000 today, and you anticipate a 2.7% annual rate of inflation over that time. How much should you save each month in actual dollars?

It may be helpful to recall that this type of problem involves two steps:

Be sure to write a sentence for each part.

• How much must you accumulate in actual dollars, to have a sum of money with the same purchasing power as $200,000 in todays dollars?
• You plan to make monthly payments, how much would you have to deposit by the end of each month to reach your goal?

b)

Now consider an alternative approach to reaching the goal of saving enough to achieve a purchasing power equivalent to $200,000 in todays dollars over the next 5 years. Instead of depositing the same number of actual dollars each month, increase each payment so that each payment has the same purchasing power in todays dollars. In other words, you increase the amount of each payment just enough to keep pace with inflation.

• How much should each payment be in todays dollars?
• By what factor must you increase the actual dollar amount of each successive payment?

Be sure to write a sentence for each question.