# Suppose you’ll have an annual nominal income of \$55,000 for each of the next 3 years, and the inflation rate is 5 percent per year.(Hint: Use the following formula): I0 / (1 + r)t where I0 is the nominal income, r is the inflation rate and t is the number of years.Instructions: Enter your responses rounded to two decimal places. Find the real value of your \$55,000 salary for each of the next 3 years.

The time value of money, or value of money over time is given by the following equation:

Future Value, FV = Present value/(1+r)^t

where, r is rate of inflation (as fraction) and t is time interval (in years, if rate of inflation is in years).

Here, present value = nominal...

The time value of money, or value of money over time is given by the following equation:

Future Value, FV = Present value/(1+r)^t

where, r is rate of inflation (as fraction) and t is time interval (in years, if rate of inflation is in years).

Here, present value = nominal salary = \$55,000, rate of inflation, r  = 5% or 0.05

For time =  1 year, FV = 55,000 / ( 1 + 0.05)^1 = \$52,380.95

For time = 2 years, FV = 55,000 / ( 1 + 0.05)^2 = \$49,886.62

For time = 3 years, FV = 55,000 / ( 1 + 0.05)^3 = \$47,511.07

Thus, the real value of a nominal salary of \$55,000 falls down to \$52,380.95 after one year, to \$49,886.62 after 2 years and to \$47,511.07 after three years. That is the reason people need increments every year to maintain their salaries at the original level.

Hope this helps.

Approved by eNotes Editorial Team