Fundamentals of Financial Manageme...
Solutions
Fundamentals of Financial Manageme...
REACHING A FINANCIAL GOAL Erika and Kitty, who are twins, just received $30,000 each for their 25th birthday. They both have aspirations to become millionaires. Each plans to make a $5,000 annual contribution to her “early retirement fund” on her birthday, beginning a year from today. Erika opened an account with the Safety First Bond Fund, a mutual fund that invests in high-quality bonds whose investors have earned 6% per year in the past. Kitty invested in the New Issue Bio-Tech Fund, which invests in small newly issued bio-tech stocks and whose investors have earned an average of 20% per year in the fund’s relatively short history.
- a. If the two women’s funds cam the same returns in the future as in the past, how old will each be when she becomes a millionaire?
- b. Flow large would Erika’s annual contributions have to be for her to become a millionaire at the same age as Kitty, assuming their expected returns are realized?
- c. Is it rational or irrational for Erika to invest in the bond fund rather than in stocks?
a.
To calculate: Number of years taken by E and K to become millionaires, if both earn same return.
Financial Goal: Financial goal is a money based target, which a person wants to achieve at a certain age. It requires making plan for reducing debt, creating enough wealth to have at the time of retirement and reducing amount of tax.
Solution:
Given for E,
Rate of return is 6%.
Present value of investment is $30,000.
Annual savings is $5000.
The “NPER” formula is to be used in excel to get the number of years.
Table (1)
Number of years E required to become a millionaire is 38.7 years which means that she will be millionaire by the age of 63.7 years
b.
To calculate: E’s contribution to become millionaire at the same age of K.
c.
To explain: Whether it is rational or irrational for E to invest in the bond fund rather than in stocks.
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