Question

Old Alfred Road MINI CASE Problem

Old Alfred Road, who is well-known to drivers on the Maine Turnpike, has reached his seventieth birthday and is ready to retire. Mr. Road has no formal training in finance but has saved his money and invested carefully.

Mr. Road owns his home - the mortgage is paid off - and does not want to move. He is a widower, and he wants to bequeath the house and many remaining assets to his daughter.

He has accumulated savings of $180,000, conservatively invested. The investments are yielding 9 percent interest. Mr. Road also has $12,000 in a savings account at 5 percent interest. He wants to keep the savings account intact for unexpected expenses or emergencies.

Mr. Road's basic living expenses now average about $1,500 per month, and he plans to spend $500 per month on travel and hobbies. To maintain this planned standard of living, he will have to rely on his investment portfolio. The interest from the portfolio is $16,200 per year (9 percent of $180,000), or $1,350 per month.

Mr. Road will also receive $750 per month in social security payments for the rest of his live. These payments are indexed for inflation. That is, they will be automatically increased in proportion to changes in the consumer price index.

Mr. Road's main concern is with inflation. The inflation rate has been below 3 percent recently, but a 3 percent rate is unusually low by historical standards. His social security payments will increase with inflation, but the interest on his investment portfolio will not.

1. What advice do you have for Mr. Road?

2. Can he safely spend all the interest from his investment portfolio?

3. How much could he withdraw at year-end from that portfolio if he wants to keep its real value intact?

4. Suppose Mr. Road will live for 20 more years and is willing to use up all of his investment portfolio over that period. He also wants his monthly spending to increase along with inflation over that period. In other words, he wants his monthly spending to stay the same in real terms. How much can he afford to spend per month?

Assume that the investment portfolio continues to yield a 9 percent rate of return and that the inflation rate will be 4 percent.

Answer 1

Solution :- P.No.1 monthly yearly 1500 18,000 Basic living Expenses Travel and Hobbies 500 6,000 dal 2,000 94,000 180,000 0.09 16,200 1350 monthly Accumulated Savings Zinterest Interest (Amt) Saving accounts Interest Interest (Amt) 12,000 0.05 600 50 Social Security payment monthley yearly 750 9,000 1.09/1.00-1/ 4.804. Real Rate of interest after adjusting inflation on accumulated savings Real rate of interest on 1.051.04-1 0.96 y. Saving bank

Can he safely spend all the interest from P. 2 his investment portfolio ? 8,640 720 750 The real value of accumulated yield 180,000 x 4.807. Social Security Total monthly income Expenditure 1,470 2,000 He Cannot spend all the interest from his invertment porfolio as expense is $2000 and the income earn is $ 14to, his only basic living expense are also not been fulfilled. How much could he withdraw at year end from that porfolio if he wants to keep its real value intact? future value in real terms 7200 180,000 0.04 Annual interest 16,200 Actual interest 9,000

P.3 The above interest is possible $9,000 only if the portfolio and interest are not utilised Suppose Mr. Road will live for 20 more years and is willing to use up all of this investment portfolio over that period Annual real interest 0.048 monthly 0.004 monthly Cash payment - Accumulated Savings I Amurity factor Annuity factol = 110.004 (10.000X1.004 340) Solving above gives 154,093 monthly Cash payment = 180,000 154.643 1168.125 742 Social Security paymat - $750

The monthy income in real would be 1168. 13 +750 $ 1918.13 So Mr. Road can spend $ 1918.13 is he uses up his portfolio in 20 yas and not $2,000 pleat, vote positively