Seminar Questions Set 2 - Q5

AB1201
FINANCIAL MANAGEMENT

NANYANG BUSINESS SCHOOL

Daniel Ong 1
 Seminar Questions Set 2 - Q5

Question 5

Required annuity payments. A father is now planning a savings

program to put his daughter through college. She just celebrated
her 13th birthday, she plans to enroll at the university in 5 years
when she turns 18 years old, and she should graduate in 4 years.
Currently, the annual cost (for everything – food, clothing,
tuition, books, transportation, and so forth) is $15,000, but these
costs are expected to increase by 5% annually. The college
requires that this amount be paid at the start of the school year.
She now has $7,500 in a college savings account that pays 6%
annually.

2
 Seminar Questions Set 2 - Q5

a) How large must each payment be if the father makes five

equal annual deposits into her account; the first deposit today
and the fifth deposit on the daughter’s 17th birthday? [Hint:
Calculate the cost (inflated at 5%) for each year of college
and find the PV of these costs, discounted at 6%, as of the
day she enters college. Then find the compounded value of
her initial $7,500 on that same day. The difference between
the PV costs and the amount that would be in the savings
account must be made up by the father’s deposits].

Sketch a clear time line:

Age 13 14 15 16 17 18 19 20 21
Year 0 1 2 3 4 5 6 7 8
6%

P P P P P F1 F2 F3 F4
$7,500 3
 Seminar Questions Set 2 - Q5
Age 13 14 15 16 17 18 19 20 21
Year 0 1 2 3 4 5 6 7 8
6%

P P P P P F1 F2 F3 F4
$7,500
PV5 is the amount she needs to have (at t=5) in her Discount at 6%
bank account in order to have just enough money to to t=5
make four annual withdrawals to pay for college fees PV5
F1 = $15,000(1 + 5%)5 = $19,144.22 (STO 1)
F2 = $15,000(1 + 5%)6 = $20,101.43 (STO 2)
F3 = $15,000(1 + 5%)7 = $21,106.51 (STO 3)
F4 = $15,000(1 + 5%)8 = $22,161.83 (STO 4)
PV5 = 19,144.22 + 20,101.43/(1.06) + 21,106.51/(1.06)2 + 22,161.83/(1.06)3
= $75,500.06 (STO 5)
Use calculator’s CF function to compute:
CF0=19144.22 (RCL 1), CF1=20101.43 (RCL 2), CF2=21106.51 (RCL 3),
CF3=22161.83 (RCL 4), I=6
CPT NPV 4
 Seminar Questions Set 2 - Q5

Age 13 14 15 16 17 18 19 20 21
Year 0 1 2 3 4 5 6 7 8
6%

P P P P P FV5
$7,500

FV5 is the amount that she needs to achieve (at t=5)

from her savings and her father’s contributions
FV5 = $75,500.06
(1.06)5 + P(1.06)5 + P(1.06)4 + P(1.06)3 + P(1.06)2 + P(1.06) = 75,500.06
7,500(1.06)
7,500

(RCL 5)
P(1.06)5 + P(1.06)4 + P(1.06)3 + P(1.06)2 + P(1.06) = 75,500.06 – 7,500(1.06)5
= 65,463.37 (STO 6)

P = $10,955.63
Use calculator’s TVM keys to solve for P:
“Begin Mode”, N=5, I=6, PV=0, FV=65463.37 (RCL 6)
CPT PMT 5
 Seminar Questions Set 2 - Q5

b) If instead, her father makes six equal annual deposits into her
account; the first deposit today and the sixth on the day she
starts college. How large must each of the six payments be?
Age 13 14 15 16 17 18 19 20 21
Year 0 1 2 3 4 5 6 7 8
6%

Q Q Q Q Q Q FV6

(RCL 6)
FV6 = $65,463.37(1 + 6%)
= $69,391.17 (STO 7)

Q(1.06)6 + Q(1.06)5 + Q(1.06)4 + Q(1.06)3 + Q(1.06)2 + Q(1.06) = 69,391.17

Q = $9,385.00
Use calculator’s TVM keys to solve for Q:
“Begin Mode”, N=6, I=6, PV=0, FV=69391.17 (RCL 7)
CPT PMT
6