Inflation is 2% per year; the interest rate is 8% per year.

Your perpetuity project has cash flows that grow at 1% faster than

inflation forever, starting with $20 next year.

1.

What is the real interest rate, both accurate (the "1

+

" ver-

sion) and approximate (the subtraction version)?

2. What is the correct project PV?

3.

What would you get if you grew a perpetuity project of $20

by the real growth rate of 1%, and then discounted it at

the nominal cost of capital?

4.

What would you get if you grew a perpetuity project of $20

by the nominal growth rate of 3%, and then discounted it

at the real cost of capital?

Performing either of the latter two calculations is not an uncom-

mon mistake in practice