BUSI 320 Comprehensive Problem 3

BUSI 320 Comprehensive Problem 3

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Use what you have learned about the time value of money to analyze each of the following decisions:

Decision #1: Which set of Cash Flows is worth more now?

Assume that your grandmother wants to give you generous gift. She wants you to choose which one of the following sets of cash flows you would like to receive:

Option A: Receive a one-time gift of $10,000 today.

Option B: Receive a $1600 gift each year for the next 10 years. The first $1600 would be

received 1 year from today.

Option C: Receive a one-time gift of $20,000 10 years from today.

Compute the Present Value of each of these options if you expect the interest rate to be 4% annually for the next 10 years. Which of these options does financial theory suggest you should choose?

Option A would be worth $__________ today.

Option B would be worth $__________ today.

Option C would be worth $__________ today.

Financial theory supports choosing Option _______

Compute the Present Value of each of these options if you expect the interest rate to be 7% annually for the next 10 years. Which of these options does financial theory suggest you should choose?

Option A would be worth $__________ today.

Option B would be worth $__________ today.

Option C would be worth $__________ today.

Financial theory supports choosing Option _______

Compute the Present Value of each of these options if you expect to be able to earn 10% annually for the next 10 years. Which of these options does financial theory suggest you should choose?

Option A would be worth $__________ today.

Option B would be worth $__________ today.

Option C would be worth $__________ today.

Financial theory supports choosing Option _______

Decision #2 begins at the top of page 2!

Decision #2: Planning for Retirement

Tom and Tricia are 22, newly married, and ready to embark on the journey of life. They both plan to retire 45 years from today. Because their budget seems tight right now, they had been thinking that they would wait at least 10 years and then start investing $2400 per year to prepare for retirement. Tricia just told Tom, though, that she had heard that they would actually have more money the day they retire if they put $2400 per year away for the next 10 years – and then simply let that money sit for the next 35 years without any additional payments – than they would have if they waited 10 years to start investing for retirement and then made yearly payments for 35 years (as they originally planned to do).

Please help Tom and Tricia make an informed decision:

Assume that all payments are made at the end of a year, and that the rate of return on all yearly investments will be 8% annually.

a)How much money will Tom and Tricia have in 45 years if they do nothing for the next 10 years, then puts $2400 per year away for the remaining 35 years?

b)How much money will Tom and Tricia have in 45 years if they put $2400 per year away for the next 10 years, then puts nothing additional away for the remaining 35 years?

c)How much money will Tom and Tricia have in 45 years if they put $2400 per year away for each of the next 45 years?

d)If Tom and Tricia wait 25 years (after the kids are raised!) before they put anything away for retirement, how much will they to put away each year for 20 years in order to have $925,000 saved up on the first day of their retirement 45 years from today?