after-tax costs

1. If a business borrows fund at 10% per year, the business has a 40% tax rate, and the annual inflation rate is

5%, what are the real after-tax costs of funds to the business?
Similarly, if an investor receives a nominal return of 8% on savings deposit, the tax rate is 30%, and the
inflation rate is 6%, what is the after-tax rate of return?

2. What do the following two quotes have in common?
a. “My wages are going up 5% a year. If only inflation weren’t 5% per year, I would be rich.”
b. “My bank is paying 10% a year, but the 8% inflation rate is just eating up all my real investment gains.”

3. Suppose the introduction of ATMs led households to hold less of their wealth as deposits in banks or savings
and loans. How would this affect measured velocity?

4. Some economists and journalists noticed that during Zimbabwe’s hyperinflation, the economy was turning to a
barter economy. Why do you think this would occur? (Related to application 3 on page 343).

5. Why do hyperinflations occur more frequently after countries lose wars than when they win?
1. If a business borrows fund at 10% per year, the business has a 40% tax rate, and the annual inflation rate is
5%, what are the real after-tax costs of funds to the business?
Similarly, if an investor receives a nominal return of 8% on savings deposit, the tax rate is 30%, and the
inflation rate is 6%, what is the after-tax rate of return?

2. What do the following two quotes have in common?
a. “My wages are going up 5% a year. If only inflation weren’t 5% per year, I would be rich.” b. “My bank
is paying 10% a year, but the 8% inflation rate is just eating up all my real investment gains.”
William’s Answer
Our text tells us (Chapter 16, page 330) that money illusion is the confusion between real and nominal
mangnitudes. The thing the quotes have in common is both people believe that inflation is keeping them from making
money, when in fact that inflation is what causes the increase in nominal wages and interest. Without inflation,
neither would increase.
My Response

3. Suppose the introduction of ATMs led households to hold less of their wealth as deposits in banks or savings
and loans. How would this affect measured velocity?

4. Some economists and journalists noticed that during Zimbabwe’s hyperinflation, the economy was turning to a
barter economy. Why do you think this would occur? (Related to application 3 on page 343).

5. Why do hyperinflations occur more frequently after countries lose wars than when they win?
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