Question

Bolzano Ltd has decided to provide an annual prize in perpetuity for a local university student who demonstrates outstanding leadership. The initial prize, to be awarded in exactly one year's time, will have a value of $500. The value of the prize will be increased in line with inflation, which can be assumed to be 2.75%. The university will invest funds today to provide for this scholarship, and the return on this investment fund is 5.25%. To set up the fund there is an initial administration cost of $100. As well, each year there is an administration cost of 1% of the value of that year's prize. Bolzano Ltd is responsible for these costs. For the scholarship to go ahead, Bolzano Ltd must provide the university with all funds today. How much does Bolzano Ltd need to provide today to the university so that the prize can be initiated?

Answer 1

inflation growth rate = 2.75%

ROI on investment funds = 5.25%

Initial admin cost = 100

Yearly admin cost = 1%

We have to use the gordon growth model to calculate the initial investment:

g = inflation rate = 2.75%

r = ROI of investment fund - Fees paid = 5.25-1% = 4.25%

P0 = [D0 x (1 + g)] / (r – g)

= 500 *(1+2.75%) / (4.25%-2.75%) = $ 34,250

Nest we need to add the initial admin cost of $ 100 to this amount.

So Bolzano Ltd need to provide $ 34,350 (i.e. 342,50+ 100) to the university so that the prize can be initiated

---------------------------------------

# Please upvote if this answer helps

# For any feedback/comments/clarification - please use the comments section