Time value of money problem background: in the u.s. education can

Time Value of Money Problem

Background: In the U.S. education can be very expensive, as you know, and most parents feel that they are responsible for enabling their children to go to college. This problem was valid when my children were 5 and 7. You should assume for Part 3 the market conditions prior to the recent market crash and subsequent turmoil.

Basic Problem:

I have two children, ages 5 and 7. If I wish to put money away beginning this year to pay for their college education, I need to identify the amount that I must save each year.

Child 1 will go to college in 11 years.

Child 2 will go to college in 13 years.

The annual interest rate will be 10 per cent and will be compounded annually.

I will need $25,000 per child per year of college for four years of college for each child.

How much must I put away each year beginning at the end of this year?

Part 1. Compute the annual payment to be made each year so that I will have exactly covered the required amounts when the second child completes the fourth year of college. As a simplifying assumption, we will assume that the college will allow a single tuition payment to be made at the end of each year. I want to put away the same amount every year until the obligation is completed.

Show the steps taken to solve the problem and explain why these steps are taken.

Part 2. How much would I have had to save if I had started the program when my second child was born, that is, when my children were zero and two?

Part 3. Identify some investment options that will yield the desired rate of return in the current market. Note: Real estate may not be an appropriate option because of the plan to contribute to the investment annually and to withdraw funds from the investment to pay the tuitions.

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