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Hello i really need some help with this question from SD-2020- AFM Question 2(a)
There is this “working3: component contribution ” . i dont understnad why do we times it with 1.04 for year 3 and 4 , where they stated that the inflation rate is 2% in year 3 and 4 . and why is there 1.022 in year 4 too.
For every extra year of inflation we multiply by (1+i) where I is the inflation rate.
At time 2 we multiply by (1.04)^2 because there are two years of inflation at 4% per year.
At time 3 we multiply by (1.04^2) x 1.02 because there are two years inflation at 4% and one year at 2%.
At time 4 we multiply. by (1.04^2) x (1.02)^2 because there are two years inflation at 4% and two years at 2%.The 1.022 is a typing mistake in the examiners answer, it should read 1.02^2.
If you are still unsure then do watch my free Paper FM (was F9) lectures on investment appraisal with inflation, because this is revision from Paper FM.
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