Tutorial 05 - Case Study (Tvm)
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TUTORIAL 05: CASE STUDY- INVESTMENT FOR EDUCATION Ram and Gauri lives in an affluent neighbourhood with their child, Sri, who is age 5. Until recently, they have felt very comfortable with their financial position. After visiting one of their relative, the couple became concerned that they were spending too much and not putting enough funds aside for both their child's future education needs and their own retirement. Ram earns $85,000 per year, but with the rising costs of education, their past contribution efforts have left them short of their financial goals. They felt that the amount of money they currently contribute to their investment plan would be sufficient for their retirement needs. What they had not accounted for was Sri's education. Ram is an alumni of Doon, a private university with an extremely high tuition of approximately $20,000 per year. Gauri graduated from one of the apex government college where tuition expense is only $2,500 per year. When Sri turns 18, the couple wishes to send him to either of these exceptional universities. They have a slight preference for the much more local Doon University. The problem, however, is that with the rate at which tuition is increasing they are not sure they can raise enough money. To assist in the calculations, assume the tuition at both universities will increase at an annual rate of 5%. Living expenses are currently estimated at $6,000 per year at both universities. This expense is expected to grow at only 3% per year. Further assume that they can deposit their money into a growth oriented mutual fund, which has historically earned a 12% return per annum (1% per month). The couple wishes to have a pre- determined monthly amount automatically drafted from their account. When Sri starts college they will slowly liquidate the account by making an annual payment to Sri, to cover tuition and living expenses at the beginning of each year for the four years he will be in college. Questions 1. How much will be the tuition and living expenses per year when Sri is ready to attend? Give an answer for each university. 2. Once Sri starts college what will his total expenses are in each of his four years? Again, give an answer for each university. 3. How much money will Ram and Gauri have to deposit per month to allow Sri to attend Doon University? How much money will have to be deposited per month to allow Sri to attend the Government University? (HINT: To answer this question you need to consider the costs of ALL four years.) 4. What if they feel the mutual fund will only yield 10%. How much will have to be deposited per month in order for Sri to attend each college? 5. What is the relationship between the amount that must be deposited monthly by the parents and the future increases in both tuition and living expenses? TUTORIAL 05: CASE STUDY- INVESTMENT FOR EDUCATION Ram and Gauri lives in an affluent neighbourhood with their child, Sri, who is age 5. Until recently, they have felt very comfortable with their financial position. After visiting one of their relative, the couple became concerned that they were spending too much and not putting enough funds aside for both their child's future education needs and their own
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Transcript of Tutorial 05 - Case Study (Tvm)
TUTORIAL 05: CASE STUDY- INVESTMENT FOR EDUCATION
Ram and Gauri lives in an affluent neighbourhood with their child, Sri, who is age 5. Until recently, they have felt very comfortable with their financial position.After visiting one of their relative, the couple became concerned that they were spending too much and not putting enough funds aside for both their child's future education needs and their own retirement. Ram earns $85,000 per year, but with the rising costs of education, their past contribution efforts have left them short of their financial goals. They felt that the amount of money they currently contribute to their investment plan would be sufficient for their retirement needs. What they had not accounted for was Sri's education.Ram is an alumni of Doon, a private university with an extremely high tuition of approximately $20,000 per year. Gauri graduated from one of the apex government college where tuition expense is only $2,500 per year. When Sri turns 18, the couple wishes to send him to either of these exceptional universities. They have a slight preference for the much more local Doon University. The problem, however, is that with the rate at which tuition is increasing they are not sure they can raise enough money.To assist in the calculations, assume the tuition at both universities will increase at an annual rate of 5%. Living expenses are currently estimated at $6,000 per year at both universities. This expense is expected to grow at only 3% per year. Further assume that they can deposit their money into a growth oriented mutual fund, which has historically earned a 12% return per annum (1% per month).The couple wishes to have a pre-determined monthly amount automatically drafted from their account. When Sri starts college they will slowly liquidate the account by making an annual payment to Sri, to cover tuition and living expenses at the beginning of each year for the four years he will be in college. Questions1. How much will be the tuition and living
expenses per year when Sri is ready to attend? Give an answer for each university.
2. Once Sri starts college what will his total expenses are in each of his four years? Again, give an answer for each university.
3. How much money will Ram and Gauri have to deposit per month to allow Sri to attend Doon University? How much money will have to be deposited per month to allow Sri to attend the Government University? (HINT: To answer this question you need to consider the costs of ALL four years.)
4. What if they feel the mutual fund will only yield 10%. How much will have to be deposited per month in order for Sri to attend each college?
5. What is the relationship between the amount that must be deposited monthly by the parents and the future increases in both tuition and living expenses?
TUTORIAL 05: CASE STUDY- INVESTMENT FOR EDUCATION
Ram and Gauri lives in an affluent neighbourhood with their child, Sri, who is age 5. Until recently, they have felt very comfortable with their financial position.After visiting one of their relative, the couple became concerned that they were spending too much and not putting enough funds aside for both their child's future education needs and their own retirement. Ram earns $85,000 per year, but with the rising costs of education, their past contribution efforts have left them short of their financial goals. They felt that the amount of money they currently contribute to their investment plan would be sufficient for their retirement needs. What they had not accounted for was Sri's education.Ram is an alumni of Doon, a private university with an extremely high tuition of approximately $20,000 per year. Gauri graduated from one of the apex government college where tuition expense is only $2,500 per year. When Sri turns 18, the couple wishes to send him to either of these exceptional universities. They have a slight preference for the much more local Doon University. The problem, however, is that with the rate at which tuition is increasing they are not sure they can raise enough money.To assist in the calculations, assume the tuition at both universities will increase at an annual rate of 5%. Living expenses are currently estimated at $6,000 per year at both universities. This expense is expected to grow at only 3% per year. Further assume that they can deposit their money into a growth oriented mutual fund, which has historically earned a 12% return per annum (1% per month).
The couple wishes to have a pre-determined monthly amount automatically drafted from their account. When Sri starts college they will slowly liquidate the account by making an annual payment to Sri, to cover tuition and living expenses at the beginning of each year for the four years he will be in college. Questions1. How much will be the tuition and living
expenses per year when Sri is ready to attend? Give an answer for each university.
2. Once Sri starts college what will his total expenses are in each of his four years? Again, give an answer for each university.
3. How much money will Ram and Gauri have to deposit per month to allow Sri to attend Doon University? How much money will have to be deposited per month to allow Sri to attend the Government University? (HINT: To answer this question you need to consider the costs of ALL four years.)
4. What if they feel the mutual fund will only yield 10%. How much will have to be deposited per month in order for Sri to attend each college?
5. What is the relationship between the amount that must be deposited monthly by the parents and the future increases in both tuition and living expenses?
1. A simple future value calculation is necessary to determine the amount of tuition and living expenses per year when Sri is ready to attend. DoonTo find the future costs of tuition,Let, n = 13,
i = 5%,PV = $20,000.
Solve for FV. FV = $37,712.98To find the future costs of living expenses,Let,
n = 13,i = 3%,PV = $6,000.
Solve for FV. FV = $8,811.20Total Expenses = $37,712.98 + $8,811.20 = $46,524.18
Government University To find the future costs of tuition,Let, n = 13,
i = 5%,PV = $2,500.
Solve for FV. FV = $4,714.12To find the future costs of living expenses, the calculation is the same as above by assumption.Let,
n = 13,i = 3%,PV = $6,000.
Solve for FV. FV = $8,811.20Total Expenses = $4,714.12 + $8,811.20 = $13,525.32
2. Doon tuition
Year 1: $37,712.98 (1.05)0 = $37,712.98Year 2: $37,712.98 (1.05)1 = $39,598.63Year 3: $37,712.98 (1.05)2 = $41,578.56Year 4: $37,712.98 (1.05)3 = $43,657.49
living expensesYear 1: $8,811.20 (1.03)0 = $8,811.20Year 2: $8,811.20 (1.03)1 = $9,075.54Year 3: $8,811.20 (1.03)2 = $9,347.80Year 4: $8,811.20 (1.03)3 = $9,628.24
Total ExpensesYear 1: $37,712.98 + $8,811.20 = $46,524.18Year 2: $39,598.63 + $9,075.54 = $48,674.17Year 3: $41,578.56 + $9,347.80 = $50,926.36
Year 4: $43,657.49 + $9,628.24 = $53,285.73
Government Universitytuition
Year 1: $4,714.12 (1.05)0 = $4,714.12Year 2: $4,714.12 (1.05)1 = $4,949.83Year 3: $4,714.12 (1.05)2 = $5,197.32Year 4: $4,714.12 (1.05)3 = $5,457.18
living expensesYear 1: $8,811.20 (1.03)0 = $8,811.20Year 2: $8,811.20 (1.03)1 = $9,075.54Year 3: $8,811.20 (1.03)2 = $9,347.80Year 4: $8,811.20 (1.03)3 = $9,628.24
Total ExpensesYear 1: $4,714.12 + $8,811.20 = $13,525.32Year 2: $4,949.83 + $9,075.54 = $14,025.37Year 3: $5,197.32 + $9,347.80 = $14,545.12Year 4: $5,457.18 + $9,628.24 = $15,085.42
3. To determine the monthly payment to cover college expenses, the present value (i.e. at the time Sri starts college) of the four year expenses must be calculated. Using the answers from question 2, combine both costs and find the present value keeping in mind that the stream of payments to Sri is a monthly annuity.
Doon
Year 1 Year 2 Year 3 Year 4
FV $46,524.18 $48,674.17 $50,926.36 $53,285.73
i 1 1 1 1
n 156 168 180 192
PMT ??? $124.99 $112.65 $101.94 $92.57
Adding all four amounts yields: $432.15
Government University
Year 1 Year 2 Year 3 Year 4
FV $13,525.32 $14,025.37 $14,545.12 $15,085.42
i 1 1 1 1
n 156 168 180 192
PMT ??? $36.34 $32.46 $29.11 $26.21
adding all four amounts yields: $124.12
4. This is the same problem as number three with the exception that the interest rate is different. The only adjustment is in the interest rate used.
i = 10/12 = .833333333
Doon
Year 1 Year 2 Year 3 Year 4
FV $46,524.18 $48,674.17 $50,926.36 $53,285.73
i .8333 .8333 .8333 .8333
n 156 168 180 192
PMT ??? $146.33 $133.79 $122.87 $113.27
Adding all four amounts yields: $516.26
Government University
Year 1 Year 2 Year 3 Year 4
FV $13,525.32 $14,025.37 $14,545.12 $15,085.42
i .8333 .8333 .8333 .8333
n 156 168 180 192
PMT ??? $42.54 $38.55 $35.09 $32.07
Adding all four amounts yields: $148.25
5. There is clearly a positive relationship between the amount the parents must invest and the increases in future tuition and living expenses.
