Scenario 12.1: Jennifer has decided to give up her pack-a-day smoking habit and invest the money she would have spent on cigarettes in a retirement account. At $6.00 a pack, Jennifer is currently spending $2,190 per year on cigarettes. Jennifer is 25 years old and plans to retire in 35 years, at age 60. She has chosen a retirement account that will earn a long-term average return of 5 percent per year. Jennifer is currently earning $40,000 annually. Assume that the average annual inflation rate will be 5 percent per year, that the cost of cigarettes will increase with inflation, and that Jennifer's income will also rise with the inflation rate.
-Refer to Scenario 12.1. By what approximate percentage will Jennifer's income increase from age 25 to age 60?

Question

Quizplus · Accepted Answer

Assuming an average annual inflation rate of 5 percent, Jennifer's income will increase by approximately 452 percent from age 25 to age 60. This is calculated using the formula: (1 + inflation rate)^number of years = (1 + 0.05)^35 = 4.52, or a 352 percent increase. However, since Jennifer's current annual income is $40,000, the increase to her income over 35 years will be from $40,000 to $180,800 ($40,000 x 4.52), which is a 452 percent increase.