Question

John is looking at several options to fund his son’s 4-year university degree.

The university fees of $45,000 a year will have be paid starting 11 years from today. He is analysing an insurance plan that pays out $45,000 a year for 4 years with the first payout 11 years from today. The insurance plan has several payment options:

Option 1
Pay $60,000 today.

Option 2
Beginning 1 year from today, pay $12,000 a year for the next 8 years.

Option 3

Beginning 1 year from today, make payments each year for the next 8 years. The first payment is $11,000 and the amount increases by 5% each year.

Answer the following questions regarding the options above:

1. (a) Calculate the present value of each option. Use a 10% discount rate.

Answer 1

Option A- Present value- $ 60,000

Option B- Present vaue- $ 64,019.11

Option C- Present vaue- $ 68,366.35

Option B
Calculation of Present value		10%
Year	Cash Flow		PV factor, 1/(1+r)^t	PV-Cash Flow-1
0	$                             -		1.000	$                  -
1	$                12,000.00		0.909	$     10,909.09
2	$                12,000.00		0.826	$       9,917.36
3	$                12,000.00		0.751	$       9,015.78
4	$                12,000.00		0.683	$       8,196.16
5	$                12,000.00		0.621	$       7,451.06
6	$                12,000.00		0.564	$       6,773.69
7	$                12,000.00		0.513	$       6,157.90
8	$                12,000.00		0.467	$       5,598.09
9			0.424	$                  -
10			0.386	$                  -
			Sum of PV	$     64,019.11

Option C
Calculation of Present value		10%
Year	Cash Flow		PV factor, 1/(1+r)^t	PV-Cash Flow-1
0	$                             -		1.000	$                  -
1	$                11,000.00		0.909	$     10,000.00
2	$                11,550.00	=11000*105%	0.826	$       9,545.45
3	$                12,127.50	=11550*105%	0.751	$       9,111.57
4	$                12,733.88	=12127.5*105%	0.683	$       8,697.41
5	$                13,370.57	=12733.88*105%	0.621	$       8,302.07
6	$                14,039.10	=13370.57*105%	0.564	$       7,924.70
7	$                14,741.05	=14039.1*105%	0.513	$       7,564.49
8	$                15,478.10	=14741.05*105%	0.467	$       7,220.65
			Sum of PV	$     68,366.35