Question

Felix Jones, a recent engineering graduate, expects a starting salary of $35,000 per year. His future employer has averaged 5% per year in salary in- creases for the last several years. If inflation is esti- mated to be 4% per year for the next 3 years, how much, in year-1 dollars, will Felix be earning each year? What is the differential inflation rate in Felix’s salary?

Answer 1

Year	Expected salary	Present value factor based on inflation	Value in Year 1 dollars	Average inflation
0	35,000	1	35,000	-
1	36,750	0.962	35,336.54	0.009615
2	38,587.50	0.925	35,676.31	0.009615
3	40,516.88	0.889	36,019.35	0.009615

Currently Felix's salary is $35,000 i.e. salary in Year 0

in year 1, expected salary = 35,000* (1 + 0.05) = $36, 750 present value factor = 1 +0,04 = 0.962 value in year 1 dollars = 36, 750 * 0.962 = $35, 336.54 35, 336.54 - 35,000 rate of inflation = -= 0.009615 35000

in year 2 expected salary = 35,000 * (1 +0.05)= $38,587.50 present value factor = (2004)2 = 0.925 value in year 1 dollars = 38,587.5 * 0.925 = $35, 676.31 35, 676.31 – 35, 336.54 rate of inflation = ? * = 0.009615 35, 336.54

in year3 expected salary = 35,000 * (1 +0.05)3 = $40,516.88 present value factor = (1 +004)3 = 0.889 value in year 1 dollars = 40,516.88 * 0.889 = 36,019.35 36,019.35 – 35, 676.31 rate of inflation = ? = 0.009615 35, 676.31

Average inflation rate is 0.9615%