TIME VALUE OF MONEY

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QUESTION
 
Richard e-mailed me that he and Monica differed about the impact of his extra spending over the past 15 years. He calculated it at about $3,000 a year. He said the total cost of $45,000 was well within his capability to make up. Monica said the cost was much higher and asked that they compute it. They had been offered an investment of $20,000 that would pay $70,000 in 20 years. They want to know if they should take it. Finally, Richard could sign up for an annuity at work. It would cost $100,000 at age 65 and provide payments of $8,000 per year over his expected 17-year life span. He wants to know if it is attractive. The appropriate market rate of return on investments is 7 percent after tax.
 
1. Calculate what the $3,000-per-year deficit, had it been invested, would have amounted to at the end of the 15-year period.
2. Explain to Richard what compounding is and how it affected the cumulative amount received in question 1.
3. Calculate the return on the proposed $20,000 investment and indicate the factors entering into your recommendation to accept or reject it.
4. Indicate the expected return on the annuity and whether it should be accepted or rejected.
5. Explain the time value of money for the financial plan using your answers to questions 1 through 4 in this part of the financial plan to help you communicate the time value information to Richard and Monica.
 

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