An investment today of $25,000 promises to return $10,000 annually for the next three years.What is the approximate real rate of return on this investment if inflation averages 6 percent annually during the period?
A)3.5 percent
B)9.7 percent
C)14.0 percent
D)20.0 percent

Question

Quizplus · Accepted Answer

To calculate the real rate of return, we need to adjust the nominal rate of return for inflation. We can use the following formula:

Real rate of return = (1 + nominal rate) / (1 + inflation rate) - 1

In this case, the nominal rate of return is $10,000 / $25,000 = 0.4, or 40 percent. The inflation rate is given as 6 percent annually.

Therefore, the real rate of return = (1 + 0.4) / (1 + 0.06) - 1 ≈ 3.5 percent.

So, the best choice is A, which is the approximate real rate of return on this investment.

An Investment Today of $25,000 Promises to Return $10,000 Annually