Question

eanette uses the serial payment approach to calculate the amount she must save each year to accumulate her desired retirement income fund. She assumes an annual inflation rate of 4%, and an annual investment rate of return of 7%. If she determines that she must save $10,000 in the first year, how much must she save in the second year to meet her goal?

$10,000

B)

$10,288

C)

$10,700

D)

$10,400

Answer 1

- She determines that the amount she must save in the first year is = $10,000

Annual Inflation rate(i) = 4%

Annual investment rate of return(r) = 7%

In Serial payment Approach, the amount to be saved in next Payment period or 2nd year(as in this case) is to be calculated by taking into consideration Inflation rate and investment rate of return.

As per the approach first we will calculate Inflation adjusted return or Real rate of Return:-

Real rate of Return = (1+r)/(1+i) - 1

Real rate of Return = (1+0.07)/(1+0.04) - 1

Real rate of Return = 2.88%

- Amount  she has to save in the second year to meet her goal = First payment*(1+Real rate of Return)

= $10,000*(1+0.0288)

Amount  she has to save in the second year to meet her goal = $10,288

Option B

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