Mike is a young executive with a pharmaceutical firm. He earns $ 100,000 per year and...

Mike is a young executive with a pharmaceutical firm. He earns $ 100,000 per year and expects his income to increase at a rate of 4% over his career. Mike estimates that he consumes 20% of his salary personally, that his combined federal and state income tax bracket is, 28% and that inflation will average 3% over his career. The riskless rate of return is 6%. Using the Capitalized Earnings Approach to calculating life insurance needs, how much life insurance should Mike purchase?

A. 2.083,333

b. $2,231,667

c. $1,977,342

d. $4,166,667

Expert Solution

The answer to the question may be diffrent as Mike's age and retirement age is not given.

Assuming Mike's age is 20 years and will be working till 60 years.

Calculation is shown in table for the present value of Mike's Income

As he will work for 41 years, average income of Mike will be $5,006,285/41 = $122,105

Formula for Capitalized Earning Approach is Average Income / Risk free rate of Return.

= $122,105/.06

= $2,035,075

Mike will require $2,035,075 life insurance.

If option is needs to be choosen, option a i.e. $2,083,333 is more appropiate.

ekkarill92 answered 1 year ago

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