You are working on a retirement plan with one of your clients. Your client just

Question

You are working on a retirement plan with one of your clients. Your client just turned 40 years old and would like to retire on his 65th birthday. Your client believes that he will need an annuity payment of $6,000 per month for the remainder of his life upon retirement and would like to fund that with the purchase of an annuity on his 65th birthday. The annuity will make its first payment one month after he makes the investment. You believe that annuity products will earn 5%/year compounded monthly. Also, you consult the mortality tables and determine that your client will have a life expectancy at age 65 of 18 years. How much should your client expect to pay for this annuity on his 65th birthday? Your client would like to start investing today to fund the purchase of this annuity on his 65th birthday You believe that your client can expect to earn 7% year compounded monthly on hi s investments. How much should your client invest monthly to meet his retirement goal? If you expect inflation to average 3.5%year over the next 20 years, what will the purchasing power of your client's first annuity payment be in today's dollars? Bonus Question 2, worth up to 5 Points. The tax reform bill that just passed the Senate includes a provision that would allow equipment purchases to be expensed in the year of acquisition as opposed to being depreciated under MACRS The tax bill also reduces the marginal tax rate on Corporations to 20% from the current 34%. If enacted, how will these changes affect the analysis of cost saving projects?

Explanation / Answer

Soln : As we are considering the life expectancy of 18 years, need to calculate the the annuity for 216 months with rate = 5/12% = 0.4167%

Use the annuity formula (sum of GP series ) or use excel to calculate the PV at 65th birthday

We will get the annuity to pay at 65th birthday = $853444

Now, we need to calculate the investment to start from today at 7% compounded monthly, no. of months till 65th birthday = 12*25 = 300

So, using the excel function PMT((1+7%/12), 300, 0 , 853444), we will get the value of investment per month = $1054.20

As it is given now that for next 20 years average rate = 3.5%, hence we wre considering that after 20 years the client is going to retire.

6000 is the first annuity payment, So, in todays dollar = 6000/(1.035)^20 (pease note we are considering the annual inflation rate)

= $3015.40 is the amount in today's value for the first annuity payment.

As taxes will become lower but depreciation made in the year of purchase, So it will affect the net income margin for the company. hence, the inflation will be lower or prices will be at lower side, hence cost saving project requires less cost to be paid by the buyer.

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