Reference no: EM133185368

THE RULE OF 72

No formula is more useful for understanding inflation than the rule of 72. Basically, the rule allows you to quickly compute how long it takes the cost of goods and services to double at various compounded rates of growth. For example, if houses were increasing in cost at 9% a year, how long would it take for the price of a home to double? The answer is easy to calculate. Simply divide 72 by the annual increase (9%) and you get the approximate number of years it takes to double the price (eight years). Of course, the same calculation can be used to predict how high food prices or auto prices will be 10 years from now.

Here's an example of how you can use the rule of 72. If the cost of going to college goes up by 6% a year, how much might you have to pay to send your child to college in 24 years (this assumes you will have a child 6 years from now) if college costs are now $10,000 a year? To find the answer, you divide 72 by 6, which show that the cost of an education would double in 12 years. It would double twice in 24 years. Your son or daughter can expect to pay $40,000 per year to attend college.

CALCULATIONS

1. If the cost of a private college education is about $30,000 per year now, what will it cost your children per year if costs go up 8% a year and your children go to college 18 years from now?

2. If the value of a home doubles in 9 years, what is the annual rate of return? (Hint: use the rule of 72 in reverse.)

3. If you put $5,000 into a savings account and earned 4.5% per year, how much money would you have in the account after 64 years?

4. If interest on the national debt is 9% a year, how long would it take for the debt to double? How long would it take if interest rates went up to 12%?