Question

Discuss and show one example of how the present value formula is a good method to determine how much is needed to save monthly, in order to have a specified sum of money at retirement age in 25 years at 8% interest.

Discuss and show one example of how the future value formula is a good method to determine how much of a lump sum is needed today, to invest for 25 years to reach a specified retirement amount, with 8% interest.

Answer 1

The present value method gives the amount to be saved monthly to reach a specific goal. This saving is calculated basis the interest rate and the corresponding present value factor of the payments

Using a financial calculator, we calculate the amount needed to be saved monthly.

Considering that you need $1,000,000 after 25 years

PV = 0

FV = 1,000,000

N = 300 ( 25 years*12 months = 300 monthly periods)

I/Y = 0.667 (8/12 is the monthly interest rate)

cpt PMT, we get PMT = 1051.50

Hence, $1051.50 is needed to be saved monthly in order to reach the goal at retirement. This is an example of how the present value is used to arrive at the monthly payments.

Future value

Here, let's say the lumpsum amount is 'x' and let the specific retirement amount be $1,000,000, then

x*(1+0.08)^25 = 1,000,000

x = $146017.90

Hence, we get the lumpsum amount needed to be invested today to get the future value at retirement.