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The Thompson's want to send their two (2) year old son Johnny to College when he...

The Thompson's want to send their two (2) year old son Johnny to College when he reaches the age of eighteen (18). They plan a four (4) year education program at a local college, where annual tuition is currently $9,000 Annually. They assume that college costs will increase at 5% & that they can earn 9% after-tax on their invested assets. How much do they need to set aside today to achieve this goal? a. $18,042.36 b. $17,473.55 c. $18,729.70 d. $18,423.37

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Answer #1

Current College Fees = $9000

Johnny will start college after 16 years

College fees increases by 5% annually

Future Value of College Fees = College Fees Now *(1+i)n, where i is the increase in college fees per year and n is the number of years

First Year college fees = 9000*(1+0.05)16 = $19645.871
Second Year college fees = 9000*(1+0.05)17 = $20628.165
Third Year college fees = 9000*(1+0.05)18 = $21659.573
Fourth Year college fees = 9000*(1+0.05)19 = $22742.551

Present Value of Future Cash Flow = CF/(1+r)n

where, CF is the cash flow in Year n and r is the required rate of return

Hence, Investment Required today = 19645.871/(1+0.09)16 + 20628.165/(1+0.09)17 + 21659.573/(1+0.09)18 + 22742.551/(1+0.09)19 = $18729.702

Hence, (c) 18729.70 is the correct option

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