A couple with a newborn son wants to save for their childs college expenses in a

Question

A couple with a newborn son wants to save for their childs college expenses in advance. The couple can establish a college fund that pays 7% annual interest. Assuming that the child enters college at age 18, the parents estimate that an amount of $40,000 per year will be required to support the childs college expenses for four years.

Determine the equal annual amounts that the couple must save until they send their child to college. (Assume that the first deposit will be made on the childs first birthday and the last deposit on the childs 18th birthday. The first withdraw will be made at the beginning of the freshman year, which also is the childs 18thbirthday.)

Explanation / Answer

Equal annual amounts of $4264 are required for the couple to save until they send their child to college.

On 18th birthday, before making the first withdrawal for the college fee, the present value (at that time ie, 18 years from now) of the future cashflows would be 40,000 + 40,000/(1.07) + 40,000/(1.072) +40,000/(1.073) = $144972

To achieve this, equal annual amounts of $4264 are required for the couple to save until they send their child to college.

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