Assume you are planning how to finance your child\'s college education. The chil

Question

Assume you are planning how to finance your child's college education. The child is 1 year old now so there are 17 years to go before your child enters college at age 18. According to your estimates you will need $90,000 in the bank at that time.

a. If you believe you can earn 6% a year, on average, between now and the time your child starts college, how much will you have to invest each year between now and then in order to reach your target?

b. It appears the annual payment required to reach your target is more than you can afford. If the most you can afford to invest each year is $1,200 what average annual rate of return must you earn in order to reach your target?

Explanation / Answer

a)According to the given information, Future value (FV)required at the age of 18= $90,000 Interest rate (Rate) = 6% Number of years (Nper) = 17 Calculating the annual payment for each year using excel sheet: Step1: Go to excel and click "Insert" to insert the function. Step2: Select the "PMT" function as we are finding the payment in this case. Step3: Enter the values as Rate = 6%; Nper = 17; PV = 0; FV = -90000 Step4: CLick "OK" to get the desired value. The value comes to "$369.7" Therefore, the Payment is $3,190.03 Note: The payment will be always in negative because it is a cash outflow for the issuer. b) According to the given information, Future value (FV)required at the age of 18= $90,000 Interest rate (Rate) = ? Number of years (Nper) = 17 Annual payment invested each year (PMT) = 1200 Calculating the rate used to reach the target using excel sheet: Step1: Go to excel and click "Insert" to insert the function. Step2: Select the "Rate" function as we are finding the interest rate in this case. Step3: Enter the values as Nper = 17; PMT = -1200; PV = 0; FV = -90000 Step4: CLick "OK" to get the desired value. The value comes to "16.47%" Therefore, the annual interest rate used to reach the target is $16.47%

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