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    Time Value of Money

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    You are saving for the college education of your two children. One child will enter college in 5 years, while the other child will enter college in 7 years. College costs are currently $10,000 per year and are expected to grow at a rate of 5 percent per year. All college costs are paid at the beginning of the year. You assume that each child will be in college for four years.

    You currently have $50,000 in your educational fund. Your plan is to contribute a fixed amount to the fund over each of the next 5 years. Your first contribution will come at the end of this year, and your final contribution will come at the date at which make the first tuition payment for your oldest child. You expect to invest your contributions into various investments which are expected to earn 8 percent per year. How much should you contribute each year in order to meet the expected cost of your children's education?

    (b) If you wanted to be safe and assume that your investments would earn 5 percent per year, how much should you contribute each year. SUGGESTION: START WITH A TIME LINE.

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    Solution Preview

    Please see the attached files. The excel file has the calculations done in excel using excel functions and the word is done using the PV/FV tables.

    We first find out the cost of the college. The first child will start in 5 years and the second in 7 years. Accordingly we find the cost starting from year 5 and going till year 10, in CF2 and CF3, both of them will be in college and so we multiply by 2 to get the amount.
    College Cost Today = $10,000, Inflation = 5%.
    CF0 = $10,000  (1.05)5 = $12,762.82  1 = $12,762.82.
    CF1 = $10,000  (1.05)6 = $13,400.96  1 = $13,400.96.
    CF2 = $10,000  (1.05)7 = $14,071.00  2 = $28,142.00.
    CF3 = $10,000 ...

    Solution Summary

    The solution has a question relating to time value of money