Download bonus case 2-3

BONUS CASE 2-3
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 shows 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.
DISCUSSION QUESTIONS FOR BONUS CASE 2-3
1.
If the cost of a private college education is about $20,000 per year now, what will it cost
your children per year if costs go up 9% a year and your children go to college 16 years
from now?
2.
If the value of a home doubles in 12 years, what is the annual rate of return? (Hint: use
the rule of 72 in reverse.)
3.
If you put $1,000 into a savings account and earned 6% per year, how much money
would you have in the account after 48 years?
4.
If interest on the national debt is 6% a year, how long would it take for the debt to
double? How long would it take if interest rates went up to 8%?
ANSWERS TO DISCUSSION QUESTIONS FOR BONUS CASE 2-3
1.
If the cost of a private college education is about $20,000 per year now, what will it cost
your children per year if costs go up 9% a year and your children go to college 16 years
from now?
Using the Rrule of 72, costs would double in 8 years (72 divided by 9). There are two
8-year periods in 16 years, meaning that costs would double twice: $40,000 then $80,000 per
year. So the cost would be $80,000 per year.
2.
If the value of a home doubles in 12 years, what is the annual rate of return? (Hint: Use
the Rule of 72 in reverse.)
Using the Rule of 72, you divide 12 into 72 and get the rate of return, which is 6%.
3.
If you put $1,000 into a savings account and earned 6% per year, how much money
would you have in the account after 48 years?
Your original $1,000 would double in 12 years (72 divided by 6 equals 12). There are
four 12-year periods in 48 years, so the amount would double four times: $2,000, $4,000, $8,000,
for an end amount of $16,000.
4.
If interest on the national debt is 6% a year, how long would it take for the debt to
double? How long would it take if interest rates went up to 8%?
Again, using the Rule of 72, it would take about 12 years at 6% (72 divided by 6) and 9
years at 8% (72 divided by 8.)