TUTORIAL 05: CASE STUDYINVESTMENT FOR EDUCATION

Ram and Gauri lives in an affluent

neighbourhood with their child, Sri, who is
age 5. Until recently, they have felt very
comfortable with their financial position.
After visiting one of their relative, the
couple became concerned that they were
spending too much and not putting enough
funds aside for both their child's future
education needs and their own retirement.
Ram earns $85,000 per year, but with the
rising costs of education, their past
contribution efforts have left them short of
their financial goals. They felt that the
amount of money they currently contribute
to their investment plan would be sufficient
for their retirement needs. What they had
not accounted for was Sri's education.
Ram is an alumni of Doon, a private
university with an extremely high tuition of
approximately $20,000 per year. Gauri
graduated
from
one
of
the
apex
government college where tuition expense
is only $2,500 per year. When Sri turns 18,
the couple wishes to send him to either of
these exceptional universities. They have a
slight preference for the much more local
Doon University. The problem, however, is
that with the rate at which tuition is
increasing they are not sure they can raise
enough money.
To assist in the calculations, assume the
tuition at both universities will increase at
an annual rate of 5%. Living expenses are
currently estimated at $6,000 per year at
both universities. This expense is expected
to grow at only 3% per year. Further
assume that they can deposit their money
into a growth oriented mutual fund, which
has historically earned a 12% return per
annum (1% per month).
The couple wishes to have a predetermined monthly amount automatically
drafted from their account. When Sri starts
college they will slowly liquidate the
account by making an annual payment to
Sri, to cover tuition and living expenses at
the beginning of each year for the four
years he will be in college.
Questions
1. How much will be the tuition and living
expenses per year when Sri is ready to
attend? Give an answer for each
university.
2. Once Sri starts college what will his total
expenses are in each of his four years?
Again, give an answer for each
university.

3. How much money will Ram and Gauri

have to deposit per month to allow Sri to
attend Doon University? How much
money will have to be deposited per
month to allow Sri to attend the
Government
University?
(HINT:
To
answer this question you need to
consider the costs of ALL four years.)
4. What if they feel the mutual fund will
only yield 10%. How much will have to
be deposited per month in order for Sri
to attend each college?
5. What is the relationship between the
amount that must be deposited monthly
by the parents and the future increases
in both tuition and living expenses?

TUTORIAL 05: CASE STUDYINVESTMENT FOR EDUCATION

Ram and Gauri lives in an affluent

neighbourhood with their child, Sri, who is
age 5. Until recently, they have felt very
comfortable with their financial position.
After visiting one of their relative, the
couple became concerned that they were
spending too much and not putting enough
funds aside for both their child's future
education needs and their own retirement.
Ram earns $85,000 per year, but with the
rising costs of education, their past
contribution efforts have left them short of
their financial goals. They felt that the
amount of money they currently contribute
to their investment plan would be sufficient
for their retirement needs. What they had
not accounted for was Sri's education.
Ram is an alumni of Doon, a private
university with an extremely high tuition of
approximately $20,000 per year. Gauri
graduated
from
one
of
the
apex
government college where tuition expense
is only $2,500 per year. When Sri turns 18,
the couple wishes to send him to either of
these exceptional universities. They have a
slight preference for the much more local
Doon University. The problem, however, is
that with the rate at which tuition is
increasing they are not sure they can raise
enough money.
To assist in the calculations, assume the
tuition at both universities will increase at
an annual rate of 5%. Living expenses are
currently estimated at $6,000 per year at
both universities. This expense is expected
to grow at only 3% per year. Further
assume that they can deposit their money
into a growth oriented mutual fund, which
has historically earned a 12% return per
annum (1% per month).

The couple wishes to have a predetermined monthly amount automatically

drafted from their account. When Sri starts
college they will slowly liquidate the
account by making an annual payment to
Sri, to cover tuition and living expenses at
the beginning of each year for the four
years he will be in college.
Questions
1. How much will be the tuition and living
expenses per year when Sri is ready to
attend? Give an answer for each
university.
2. Once Sri starts college what will his total
expenses are in each of his four years?
Again, give an answer for each
university.

3. How much money will Ram and Gauri

have to deposit per month to allow Sri to
attend Doon University? How much
money will have to be deposited per
month to allow Sri to attend the
Government
University?
(HINT:
To
answer this question you need to
consider the costs of ALL four years.)
4. What if they feel the mutual fund will
only yield 10%. How much will have to
be deposited per month in order for Sri
to attend each college?
5. What is the relationship between the
amount that must be deposited monthly
by the parents and the future increases
in both tuition and living expenses?

1. A simple future value calculation is necessary to determine the amount of tuition and living expenses per year when Sri is ready to attend.
Doon
To find the future costs of tuition,
Let, n = 13,
i = 5%,
PV = $20,000.
Solve for FV. FV = $37,712.98
To find the future costs of living expenses,
Let,
n = 13,
i = 3%,
PV = $6,000.
Solve for FV. FV = $8,811.20
Total Expenses = $37,712.98 + $8,811.20 = $46,524.18
Government University
To find the future costs of tuition,
Let, n = 13,
i = 5%,
PV = $2,500.
Solve for FV. FV = $4,714.12
To find the future costs of living expenses, the calculation is the same as above by assumption.
Let,
n = 13,
i = 3%,
PV = $6,000.
Solve for FV. FV = $8,811.20
Total Expenses = $4,714.12 + $8,811.20 = $13,525.32
2. Doon
tuition
Year 1:
Year 2:
Year 3:
Year 4:
living expenses
Year 1:
Year 2:
Year 3:
Year 4:
Total Expenses
Year 1:
Year 2:
Year 3:

$37,712.98 (1.05)0 = $37,712.98

$37,712.98 (1.05)1 = $39,598.63
$37,712.98 (1.05)2 = $41,578.56
$37,712.98 (1.05)3 = $43,657.49
$8,811.20 (1.03)0 = $8,811.20
$8,811.20 (1.03)1 = $9,075.54
$8,811.20 (1.03)2 = $9,347.80
$8,811.20 (1.03)3 = $9,628.24
$37,712.98 + $8,811.20 = $46,524.18
$39,598.63 + $9,075.54 = $48,674.17
$41,578.56 + $9,347.80 = $50,926.36

Year 4: $43,657.49 + $9,628.24 = $53,285.73

Government University
tuition
Year 1: $4,714.12 (1.05)0 = $4,714.12
Year 2: $4,714.12 (1.05)1 = $4,949.83
Year 3: $4,714.12 (1.05)2 = $5,197.32
Year 4: $4,714.12 (1.05)3 = $5,457.18
living expenses
Year 1: $8,811.20 (1.03)0 = $8,811.20
Year 2: $8,811.20 (1.03)1 = $9,075.54
Year 3: $8,811.20 (1.03)2 = $9,347.80
Year 4: $8,811.20 (1.03)3 = $9,628.24
Total Expenses
Year 1: $4,714.12 + $8,811.20 = $13,525.32
Year 2: $4,949.83 + $9,075.54 = $14,025.37
Year 3: $5,197.32 + $9,347.80 = $14,545.12
Year 4: $5,457.18 + $9,628.24 = $15,085.42
3. To determine the monthly payment to cover college expenses, the present value (i.e. at the time Sri starts college) of the four year expenses
must be calculated. Using the answers from question 2, combine both costs and find the present value keeping in mind that the stream of
payments to Sri is a monthly annuity.
Doon

FV
i
n
PMT ???

Year 1
$46,524.18
1
156
$124.99

Year 2
$48,674.17
1
168
$112.65

Year 3
$50,926.36
1
180
$101.94

Year 4
$53,285.73
1
192
$92.57

Adding all four amounts yields: $432.15

Government University
Year 1
FV
$13,525.32
i
1
n
156
PMT ???
$36.34

Year 2
$14,025.37
1
168
$32.46

Year 3
$14,545.12
1
180
$29.11

Year 4
$15,085.42
1
192
$26.21

adding all four amounts yields: $124.12

4. This is the same problem as number three with the exception that the interest rate is different. The only adjustment is in the interest rate used.
i = 10/12 = .833333333
Doon

FV
i
n
PMT ???

Year 1
$46,524.18
.8333
156
$146.33

Year 2
$48,674.17
.8333
168
$133.79

Year 3
$50,926.36
.8333
180
$122.87

Year 4
$53,285.73
.8333
192
$113.27

Adding all four amounts yields: $516.26

Government University
Year 1

Year 2

Year 3

Year 4

FV
i
n
PMT ???

$13,525.32
.8333
156
$42.54

$14,025.37
.8333
168
$38.55

$14,545.12
.8333
180
$35.09

$15,085.42
.8333
192
$32.07

Adding all four amounts yields: $148.25

5. There is clearly a positive relationship between the amount the parents must invest and the increases in future tuition and living expenses.