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Yearly Savings Calculations

Assume that you would like to purchase a home in the next 5 years. Also assume that you have already saved $50,000 so far and the approximate cost of the house is $250,000. Calculate how much you need to save for the next five years to purchase this home and put down 20% as a down payment. Using the following Web site: http://www.proteam-corvette.com/1967.html

Base the interest rate on the 5-year interest rate from the Treasury department: http://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=yield
- Calculate the required yearly savings on $50,000.
- How much money could be made using the same interest rate with the amount of yearly cash flows that would have been saved for the investment if these amounts had been invested instead?
- Which is the best option? Why?

Solution Preview

If a person has $ 50,000 and wants to purchase a home in next 5 years, then the amount, which the person will require to save each year is calculated as below:
Current Saving = $50,000
Cost of new house = $250,000
Down payment = 20%
Amount of down payment = $250,000*20% => $50,000
It is assumed that a down payment of $50,000 (20% of total purchase price of home) will be paid as down payment immediately (t = 0) then total amount that will require to purchase a home in the next five years will be-
= Cost of house - down payment
= 250,000 - 50,000
= $200,000
After the down payment, an amount of $200,000 will be needed to pay for the home. In order to arrange this amount, there is need to save a certain amount yearly. The payment for yearly saving on constant payments and a constant interest rate (5-year treasury interest rate) can be determined by using the following formula:
A= F[i/((1+i)^n- 1)]
(MacDonald, 2010).
Where,
A = Annuity value
F = Future value => $200,000
i = 1.62% (5-year daily yield curve interest rates) (U.S. Department of the Treasury, ...

Solution Summary

This solution explains how a problem of corporate finance of multiple but equal cash flows can be solved, with step-by-step calculations and explanations.

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