A father wants to save for his 8-year-old son\'s college expenses. The son will

Question

A father wants to save for his 8-year-old son's college expenses. The son will enter college 10 years from now. An annual amount of $40,000 in today's constant dollars will be required to support the son's college expenses for four years. Assume that these college payments will be made at the beginning of the school year. The future general inflation rate is estimated to be per year, and the market interest rate on the savings account will average 8% compounded annually. Given this information, (a) What is the amount of the son's freshman-year expense in terms of actual dollars? (b) What is the equivalent single-sum amount at the present time for these college expenses? (c) What is the equal amount, in actual dollars, the father must save each year until his son goes to college?

Explanation / Answer

expected inflation = 0.06 or 6%

a) Freshman Actual dollar terms expense = 40000(F/P,6,10) = $71633.91

b) Effective interest = .08-.06 / (1+.06) = 0.018868

Present equivalent sum amount = (40000 + 40000(P/A,1.8868,3))(P/F,1.8868,10) = 129079.93

c) Annual Saving = 129079.93(A/P,8,10) = 19236.72

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