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Serial payment is really a term of art. It is a payment that increases each period to keep up with inflation. Assume the following information:
- Term is 5 years (n = 5)
- Inflation is 3.5%
- Rate of return is 9%. The inflation adjusted return is 5.314 calculated as: 1.09 / 1.035 – 1 x 100 (i = 5.314)
- Future value needed is $200,000
The calculation for the first payment is to figure the PV of $35,968.65 from the information above and then multiply this by the inflation rate. Thus, the first payment is $37,227.55 ($35,968.65 x 1.035). The second payment is $37,227.55 x 1.035 = $38,530.52. You continue to grow each payment at the rate of inflation for the life of the problem.
This calculation is assuming that all payments will be in the same real dollars, as each increased payment is equal to the prior payment after you consider the impact of inflation. Lastly, a considerable assumption being made with the serial payment calculation is that inflation will be constant throughout the life of the loan.
