Effect of inflation on purchasing power of bond (LO16-2) Seventeen years ago, the Archer Corporation borrowed $6,000,000. Since then, cumulative inflation has been 65 percent (a compound rate of approximately 3 percent per year).
a. When the firm repays the original $6,000,000 loan this year, what will be the effective purchasing power of the $6,000,000? (Hint: Divide the loan amount by one plus cumulative inflation.)
- To maintain the original $6,000,000 purchasing power, how much should the lender be repaid? (Hint: Multiply the loan amount by one plus cumulative inflation.)
c. If the lender knows he will receive only $6,000,000 in payment after 17 years, how might he be compensated for the loss in purchasing power? A descriptive answer is acceptable.
The lender will have to increase the interest rate to compensate for the loss in purchasing power.
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