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Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977

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BuyFindarrow_forward

Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977
Textbook Problem

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.

  1. 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?
  2. 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?
  3. c. Is it rational or irrational for Erika to invest in the bond fund rather than in stocks?

a.

Summary Introduction

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.

Explanation

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 (25+38.7)

b.

Summary Introduction

To calculate: E’s contribution to become millionaire at the same age of K.

c.

Summary Introduction

To explain: Whether it is rational or irrational for E to invest in the bond fund rather than in stocks.

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