Question

QUESTION 2 [CLO 3]

Case Scenario:

Two best friends, Ben and Arthur, who grew up together in the same neighbourhood, are the same age and they graduated from high school together. At age 19, both friends started working at different companies but earning similar salaries.

Ben started investing $2,000 at the beginning of each year from his salary for retirement, at a rate of 12%, while Arthur decided to "enjoy life" with his salary. After 8 years (age 27) the friends had a discussion about their financial happenings over the period. Their explanation for doing what they did with money was so convincing to the other.

Arthur changed his focus and wanted to do more with his income, so he started investing $2,000 for retirement at the beginning of each year at 12% until he retired at age 65 (39 years later).

Ben realized he was not having as much fun as Arthur and decided to stop investing for just a few years. However,he never managed to invest another dollar towards retirement at age 65. Ben did not touch any of his previous investment and it continued to earn interest over the next 39 years.

1. In your assessment, who will have the higher retirement value at age 65, Ben or Arthur (no calculation required)? Justify your response.                                            

2. What is Ben’s investment total at the end of year 8?(4Marks)

3. What is Ben’s total investment value at retirement (age 65)? (2Marks)

4. What is Arthur’s total investment value at retirement (age 65)?

5. Based on the assessment of your calculations, what would you say is the main reason for there to be such a big difference between both retirement values at age 65?

Answer 1

a) In my assessment Ben will have the higher retirement value as he was doing SIP till year 8 but he invested the sum of money generated thereafter till his retirement while Authur was doing SIP of $2000 annully till retirement and his time period of investment as well as investment amount bothe are low as comapared to Ben.

b) Ben's Investment total at the end of year 8

Investment amount = $ 2000 per year

Interest rate (r) = 12%

No of years (n) = 8

Future Value of annuity = Invested amount * { (1+ r)n - 1 / r}

= 2000 * {(1+0.12)8 - 1 / 0.12}

= $ 24599.384

c) Ben's totat investment value at the age of retirement

  after 8 years Ben's Total investment value will remain invested till the age of retirement

so Investment amount after 8 years = $ 24599.384 (calculated above)

interest rate = 12%

No. of years = 39

Now

Future value of this amount = Investment amount * (1+ r)n

= 24599.384 * (1 + 0.12)39

= 24599.384 * 83.081

= $ 2043746.92

d ) Arthur's total investment at the age of retirement

Investment amount = $ 2000

Interest rate = 12%

  no. of years = 39

So

Future Value of annuity = Invested amount * { (1+ r)n - 1 / r}

= 2000 * {(1+0.12)39 - 1 /0.12}

= $ 1368020.39

e) Explaination is given in part a