Question

Answer the two questions below in Excel using the WAAC Model.

1. You are considering a pair of GICs (guaranteed investment contracts) o§ered by two di§erent life insurance companies. Each promises a single payment 10 years from now.

(a) US Life Insurance Companyís GIC promises to pay 6.5% per annum and can be purchased today for $100,000.

(b) Met Lifeís GIC promises to pay 5.7% per annum compounded monthly and can be purchased today for $95,000.

Which would you buy?

2. The Board of Administrators of Tulane University has decided to o§er an early retirement program to University faculty. The typical 55-year old faculty member would receive a small cash severance payment and a pension of $50,000 per year for the next 30 years, to begin one year from now. As CFO, you plan to set aside now enough money to fully fund the pension. Youíve been assured by your insurance company that they will pay you a 7% annual return on fund deposited with them. The American Association of University Professors objects to this program, however, because, they say, it fails to account for ináation. They propose an alternative plan in which payments would begin at $40,000 for the Örst year and grow thereafter at a Öxed rate of 5% to accommodate expected increases in the cost of living. They argue that this plan should be good for the University too because it involves lower initial payments. How much will it cost you up front to fund each of these plans?

Answer 1

Suggested Answer for Q1

Companies Issuing GIC		US LIFE Insurance Company	Met Life GIC
Investment Amount		100000	95000
Interest Rate	Per Annum	0.065
	Compounded Monthly Per annum		0.057
Period	in years	10	10
Compounding Frequecy per Year		1	12
Future Value of the Investment		=E3*(1+E4/E7)^E6*E7 i.e. 187713.75	=F3*((1+(F5/F7))^(F6*F7)) i.e. 167758.83
Considering the Future value on the Investment with the given rate of Interest and Invesetment amount it is advisable to invest in US Life Insurance Company If we increase the investment amount for Met Life equivalent to the US Life, the future value generated under US Life is greater in value than Met Life. Also, If we decrease the investment amount for US Life equivalent to the Met Life, the future value generated under US Life is greater in value than Met Life. Note: Tax-rates not taken into consideration

Suggested Answer for Q2

Amount to be funded per annum towards the Pension	50000				Amount to be funded per annum towards the Pension	40000
Total number of years for which the pension to be made	30				Total number of years for which the pension to be made	29
Total Outflow that needs to be funded right now	=+N2*N3				Total Outflow that needs to be funded right now	=+S2*S3
Year	Investment amount at a decreasing rate of 50000 per year	Rate of Interest Offered per year by the Insurance company on the deposit made	Interest Earned per year		Year	Amount to funded every year towards pension with 5% increase	Assumed increase in cost of living to be added up each year	Amount to be set aside each year considerig 5% increase in cost of living
1	=50000*30	0.07	=+N6*(1+O6)-N6		1	40000	0.05	=+S6*T6
2	=+N6-50000	0.07	=+N7*(1+O7)-N7		2	=+S6+U6	0.05	=+S7*T7
3	=+N7-50000	0.07	=+N8*(1+O8)-N8		3	=$S$6+U7	0.05	=+S8*T8
4	=+N8-50000	0.07	=+N9*(1+O9)-N9		4	=+S8+U8	0.05	=+S9*T9
5	=+N9-50000	0.07	=+N10*(1+O10)-N10		5	=+S9+U9	0.05	=+S10*T10
6	=+N10-50000	0.07	=+N11*(1+O11)-N11		6	=+S10+U10	0.05	=+S11*T11
7	=+N11-50000	0.07	=+N12*(1+O12)-N12		7	=+S11+U11	0.05	=+S12*T12
8	=+N12-50000	0.07	=+N13*(1+O13)-N13		8	=+S12+U12	0.05	=+S13*T13
9	=+N13-50000	0.07	=+N14*(1+O14)-N14		9	=+S13+U13	0.05	=+S14*T14
10	=+N14-50000	0.07	=+N15*(1+O15)-N15		10	=+S14+U14	0.05	=+S15*T15
11	=+N15-50000	0.07	=+N16*(1+O16)-N16		11	=+S15+U15	0.05	=+S16*T16
12	=+N16-50000	0.07	=+N17*(1+O17)-N17		12	=+S16+U16	0.05	=+S17*T17
13	=+N17-50000	0.07	=+N18*(1+O18)-N18		13	=+S17+U17	0.05	=+S18*T18
14	=+N18-50000	0.07	=+N19*(1+O19)-N19		14	=+S18+U18	0.05	=+S19*T19
15	=+N19-50000	0.07	=+N20*(1+O20)-N20		15	=+S19+U19	0.05	=+S20*T20
16	=+N20-50000	0.07	=+N21*(1+O21)-N21		16	=+S20+U20	0.05	=+S21*T21
17	=+N21-50000	0.07	=+N22*(1+O22)-N22		17	=+S21+U21	0.05	=+S22*T22
18	=+N22-50000	0.07	=+N23*(1+O23)-N23		18	=+S22+U22	0.05	=+S23*T23
19	=+N23-50000	0.07	=+N24*(1+O24)-N24		19	=+S23+U23	0.05	=+S24*T24
20	=+N24-50000	0.07	=+N25*(1+O25)-N25		20	=+S24+U24	0.05	=+S25*T25
21	=+N25-50000	0.07	=+N26*(1+O26)-N26		21	=+S25+U25	0.05	=+S26*T26
22	=+N26-50000	0.07	=+N27*(1+O27)-N27		22	=+S26+U26	0.05	=+S27*T27
23	=+N27-50000	0.07	=+N28*(1+O28)-N28		23	=+S27+U27	0.05	=+S28*T28
24	=+N28-50000	0.07	=+N29*(1+O29)-N29		24	=+S28+U28	0.05	=+S29*T29
25	=+N29-50000	0.07	=+N30*(1+O30)-N30		25	=+S29+U29	0.05	=+S30*T30
26	=+N30-50000	0.07	=+N31*(1+O31)-N31		26	=+S30+U30	0.05	=+S31*T31
27	=+N31-50000	0.07	=+N32*(1+O32)-N32		27	=+S31+U31	0.05	=+S32*T32
28	=+N32-50000	0.07	=+N33*(1+O33)-N33		28	=+S32+U32	0.05	=+S33*T33
29	=+N33-50000	0.07	=+N34*(1+O34)-N34		29	=+S33+U33	0.05	=+S34*T34
30	=+N34-50000	0.07	=+N35*(1+O35)-N35		30	=+S34+U34	0.05	=+S35*T35
			=SUM(P6:P35)			=SUM(S6:S35)
	Plan1	Plan 2
Total Outlay	=+N4	=+S36
Interest earned on the Total Outlay	=+P36	0
Net Amount in hand after 30years after setting aside the outflow in year 1	=+N40-N39	0
Though initial out lay is high in Plan 1 - still we can go ahead with Plan 1 of Depositing with Insurance company at 7%. Since such interest earned at the diminishing balance itself is over and above the level of actual investment made in year 1. Also, the pensioners are well of after their service which will get a good reputation to the organization