###
**CFA Practice Question**

Inflation is expected to average 3.5% over each of the next five years. If an annuity pays $7,250 per year, at year-end, what is its present value if investors demand a real return of 3%?

A. $30,129

B. $33,203

C. $35,713

**Explanation:**Investors require a rate of return = real rate + inflation premium = 3 + 3.5 = 6.5%

Using a financial calculator: PMT = 7,250; I/Y = 6.5; N = 5; CPT PV = 30,129

###
**User Contributed Comments**
9

User |
Comment |
---|---|

danlan |
Another way is to use CF, C01=7250, F01=5, I=6.5 ==> NPV=30129 |

CjjCjj |
you would use the real rate of return only if the annuity paid an inflation adjusted amount. |

copus |
be careful on these annuity questions - they will try to trip you up by the timing of the annuity payment (ie at the beginning or at the end of the year). |

jansen1979 |
One should add FV = 0 to above calculator technique. |

mixer |
always remember to 2nd clr TVM wnenever going for a new calculation you avoid write offs |

Oksanata |
why would they say that investors DEMAND 3% return? messing up.... |

CalebMast |
Yeah, the 0 for FV tripped me up on calculator. Notes on beginning of year and only if inflation adjusted quite helpful. @Oksanata - the demanded return gets added to inflation. Inflation is not return. Real return is above inflation - really it's "above and beyond" inflation, so stated real return demanded by investors is simply added to inflation (considered base, or even faux) #. |

IreneK |
The calculator gives me -32,087 as a result... I can't get what's wrong... |

mmccoy |
@Irenek set your calculator to END mode. You get 32,087 in BGN mode. |