Question

Tuition costs are expected to increase at a rate of 8% per year. The first year's tuition is due one year from now and will be $2,000. A fund is to be set up today to cover tuition costs for 4 years in an account that will earn interest rate (i). How large must the fund be if:

(a) i = 5%

(b) i = 8%

(c) i = 10%

Answer 1

Rate of inflation, g = 8%

n = 4

CF1 = 2,000

(a) i = 5%

The fund must be as large as $7,951.8422866667 if i = 5%

(b) i = 8%

When i = g, the present value is equal to (PMT * n)/(1 + i)

PV = (2,000 * 4)/(1 + 0.08)

PV = 8,000/1.08

PV = 7,407.4074074074

The fund must be as large as $7,407.4074074074 if i = 8%

(c) i = 10%

The fund must be as large as $7,076.773444 if i = 10%