Question

4. (a) Studebaker is eligible to put 12,000 before-tax dollars each year into a tax-deferred annuity (TDA). In order to invest in a TDA, however, he must have his salary reduced, and the case indicates that he can afford a reduction in his spendable income of $3,052 each year without disrupting his lifestyle. One investment option is to encrease the amount placed into a TDA each year to the legal maximum of $12,000 and move funds from the money market to cover the resulting shortfall in Studebaker's spendable income. How much money will he need to transfer each year from the money market? (b) Assume Studebaker will earn a 4 percent after-tax annual return in the money market. For how many years can he contribute the maximum amount to the TDA and cover any shortfall in his spendable income with funds from the money market? (Round your answer to the next highest year.) (c) How many after-tax dollars will be accumulated in 20 years if the legal maximum is placed in the TDA as long as possible and a 7-percent annual return is earned? (Keep in mind that Studebaker would reduce the annual amount invested in the TDA when the funds in the money market are exhausted. ) (d) Redo your answer to part (c) assuming 8 percent is earned during years 1 to 10, 5 percent during years 11 to 15, and 7 percent in years 16 to 20.

Answer 1

A Money to be transferred from Money Market = Eligible amount each year in TDA – Reduction possible in spendable income without disrupting life style

= $12000 – $3052 = $8948

B As long as he can withdraw money from money market

C Amount accumulated in 20 years = 20 years annuity of $ 12000 at 7% (using financial calculator)

At N = 20, I/Y = 7, PV = 0, PMT = 12000, CPT FV

=$491946

D Amount accumulated in 20 years = FV of 10 years annuity at 8% + FV of 5 years annuity at 5% + FV of 5 years annuity at 7% (using financial calculator as in C above)

=$ 473188.87