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NISM Certifications · NISM-Series-X-A: Investment Adviser (Level 1) · Introduction to Personal Financial Planning

Mr. Sameer Joshi, aged 40, estimates that his family needs Rs 60,000 per month today. He wants to know the monthly requirement after 2 years if inflation is 10% per annum, compounded annually. What will be the approximate monthly requirement, and which common error would give Rs 72,000?

The requirement becomes Rs 72,600, since 60,000 multiplied by 1.10 squared equals 72,600. The figure of Rs 72,000 arises from adding simple inflation of 20% over two years, which ignores the compounding of inflation on the first year's increase.

  1. ARs 72,600; the error is ignoring compounding and using simple inflation of 20%Correct
  2. BRs 72,000; the error is compounding for 3 years
  3. CRs 66,000; the error is using one year of inflation
  4. DRs 72,600; the error is discounting instead of compounding

Explanation

Future value = 60,000 x 1.10^2 = 60,000 x 1.21 = Rs 72,600. Simple inflation of 10% for 2 years gives 60,000 x 1.20 = Rs 72,000, which omits compounding. Option 2 is wrong as 3 years would give about Rs 79,860, and Option 3 is one year only. Discounting would reduce the amount to about Rs 49,587, not give Rs 72,000.

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