Question

Pr. 1-Present value and future value computations. Part (a) Compute the amount that a $40,000 investment today would accumulate at 10% (compound interest) by the end of 6 years. Part (b) Tom wants to retire at the end of this year (2014). His life expectancy is 20 years from his retirement. Tom has come to you, his CPA, to learn how much he should deposit on December 31, 2014 to be able to withdraw $60,000 at the end of each year for the next 20 years, assuming the amount on deposit will earn 8% interest annually. Part (c) Judy Thomas has a $2,100 overdue debt for medical books and supplies at Joe's Bookstore. She has only $700 in her checking account and doesn't want her parents to know about this debt. Joe's tells her that she may settle the account in one of two ways since she can't pay it all now: 1. Pay $700 now and $1,750 when she completes her residency, two years from today. Pay $2,800 one year after completion of residency, three years from today. 2. Assuming that the cost of money is the only factor in Judy's decision and that the cost of money to her is 8%, which alternative should she choose? Your answer must be supported with calculations. 3

Answer 1

1. Final value=initial*(1+rate)^n
   =4000*(1+10%)^6=$70,862.44
2. We use pv formulae in excel to find this
   =pv(rate,nper,pmt,fv,type)
   Rate=8%
   Nper=20
   Pmt=60000
   Fv=0
   Type=0
   =pv(8%,20,60000,0,0)
   =$589,088.84
   
3. We will evaluate both options
   Option 1:
   Value of this option today is
   =700+(1750/((1+8%)^2)=$2200.34
   Option 2:
   Value of 2800 now which is paid three years from today is
   =2800/((1+8%)^3)=$2222.73
   So for her it would be better to use option 1 as less outflow of money happened in this case.