After completing your Bachelor of Business degree, let’s assume that you secured

Question

After completing your Bachelor of Business degree, let’s assume that you secured a permanent
position as an accountant. Your financial plan is to retire in 35 years from now. So you are
thinking about creating a fund that will allow you to receive $36,000 at the end of each year for
25 years after your retirement. Your expected return on savings is 6.25% per annum during the
25-year retirement period.
Required:
a. To provide the 25- year, $36,000 a year annuity, calculate how much should be in the
fund account when you retire in 35 years’ time. (2 marks)
b. How much will you need today as a single amount to provide the fund calculated in part
(a) if you earn 6.35% per year during the 35 years preceding retirement? (2 marks)
c. What effect would an increase in the interest rate, both during and prior to retirement,
have on the values calculated in parts (a) and (b)? Explain why. (2 marks)
d. Assume that you will earn 6.95% per annum on your savings during the 35 years
preceding your retirement and 6.55% during the 25-year period after your retirement.
To fund the 25- year stream of $36,000 annual annuity payments, you will be making
end-of-year deposits for 35 years. How much do you need to deposit annually?
(3 marks) After completing your Bachelor of Business degree, let’s assume that you secured a permanent
position as an accountant. Your financial plan is to retire in 35 years from now. So you are
thinking about creating a fund that will allow you to receive $36,000 at the end of each year for
25 years after your retirement. Your expected return on savings is 6.25% per annum during the
25-year retirement period.
Required:
a. To provide the 25- year, $36,000 a year annuity, calculate how much should be in the
fund account when you retire in 35 years’ time. (2 marks)
b. How much will you need today as a single amount to provide the fund calculated in part
(a) if you earn 6.35% per year during the 35 years preceding retirement? (2 marks)
c. What effect would an increase in the interest rate, both during and prior to retirement,
have on the values calculated in parts (a) and (b)? Explain why. (2 marks)
d. Assume that you will earn 6.95% per annum on your savings during the 35 years
preceding your retirement and 6.55% during the 25-year period after your retirement.
To fund the 25- year stream of $36,000 annual annuity payments, you will be making
end-of-year deposits for 35 years. How much do you need to deposit annually?
(3 marks)

Explanation / Answer

C) An increase in increase rate in both cases will reduce our financial obligation or amount required in the retirement fund. If the pre retirement interest rates are increased we will be able to get better returns the our lumpsum or periodic contribution to the retirement fund account. Similarly if the post retirement interest rates are increased the amount existing in our retirement amount will compound fast giving better returns and as a result reducing our financial obligation to fund an annuity of 36000 a year. Therefore an invrease in interest rates is good for the investor

D)

Explanation: We first calculate the amount required at the stage of retirement to let him take out 36000 for next 25 year period at rate 6.95% as given; Inputs: Rate=6.95% N= 25, PMT=36000,Fv=0, Cal PV from Excel or Financial Calculator

After this find the amount you need to contribute annually to find this retirement fund by using rate of return R = 6.95%, N= 35 PV=0, FV = -437099.58, Cal PMT

A) No. of years to retirement 35 Amount required each year from the pension plan (PMT) 36000 No. of years after retirement the amount will be required (N) 25 Expected returns on savings during the 25 yr retirement period (I/Y) 6.25% To withdraw 36000 amount for next 25 years after retirement, at the stage of retirement the fund account should have balance of (PV) -449468.40

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