Question

19. You are currently 43 years old and expect to retire in 25 years, and then you expect to live for another 20 years after retirement. Your current labor income is about $60,000. Assuming you have no savings, how much do you need to save from this point until retirement in order to replace 75% of your current income during retirement? (Assume no increase in wage and that your rate of interest will exceed inflation by 3%) (4 pts)

20. Cindy, who will graduate from college in a year is deciding whether to go on for her master’s degree which will last two years. She figures that if she takes a job immediately, she can earn $40,000 per year in real terms for the remainder of her working years. If she goes on for two more years of graduate study, however, she can increase her earnings to $50,000 per year. The cost of tuition is $40,000 per year in real terms. Is this a worthwhile investment if the real interest rate is 5% per year?—(Assume she will retire after working for 40 years. AND SHOW YOUR WORK)—4 pts.

Answer 1

Q#19:

Income before retirement= $60,000 per year

Retirement income needed (75% of above)= 60,000*75% = $45,000

Real interest rate= 3%

Amount needed on retirement=   $669,486.37 as follows:

Annual savings required between now and retirement= $18,362.59 as follows:

Q#20:

It is assumed that she will work 40 years, in either of the options ie., 40 years from now in option 1 and 40 years after 2 year study in option 2.

Option 1:

Present value of income= $686,363.45 as follows:

Option 2:

Present value of income after 2 years = $857,954.32 as follows:

PV of the above amount now= $857,954.32/(1+5%)^2 = $ 778,189.86

PV of cost of tuition for 2 years= $74,376.42 as follows:

Net present value of option 2= 778,189.86 - 74,376.42= $703,813.44

Since the net income, in present value terms, is higher for option 2, joining for masters is a worthwhile investment.