Question

Babu is saving for his son’s college tuition. His son is currently 11 years old and will begin college in seven years. Babu has an index fund investment worth $7,500 that is earning 9.5 percent annually. Total expenses at the Black Hills State University, where his son says he plans to go, currently total $15,000 per year, but are expected to grow at roughly 6 percent each year. Babu plans to invest in a mutual fund that will earn 11 percent annually to make up the difference between the college expenses and his current savings. In total, Babu will make seven equal investments with the first starting today and with the last being made a year before his son begins college. (12 points)

1. What will be the present value of the four years of college expenses at the time that Babu’s son starts college? Assume a discount rate of 5.5 percent.
2. What will be the value of the index mutual fund when his son just starts college?
3. What is the amount that Babu will have to have saved when his son turns 18 if Babu plans to cover all of his son’s college expenses?
4. How much will Babu have to invest every year in order to have enough funds to cover all his son’s expense?

Answer 1

 

a. Determination of present value of college fees:

 

The tuition fees will start from the 7th year.

 

Hence, the present value of college fees is $86,124.36.

 

b. Determination value of index mutual fund:

 

Hence, the value of index mutual is $14,156.64.

 

c. Determination amount to be saved:

 

Hence, the amount to be saved is $71,967.73.

d. Determination of annual savings:

Hence, the annual savings is $6,627.21.