Time Value of Money
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1. Bozeman's Best Inc. is establishing a pension plan for its sole employee. He will receive credit for 12 years of prior service and is expected to work 18 years until retirement. After retirement, he is expected to collect annual pension payments for 17 years. His current salary is $75,000 with estimated future pay increases to average 5% per year. What will be the initial amount of projected benefit obligation (i.e., prior service cost) at the inception of the plan if the benefit formula is final year's annual salary times years of service times 2%? You may assume ordinary annuities and end-of-year annual payments upon retirement and 8% per annum discount rate.
2. Using the facts above (but not related to the answer to #1), assume that the Bozeman's Best pension plan must have $869,000 in plan assets at the date the employee retires. If the company wants to make 18 equal annual payments at the end of each year of service to fund the plan, what is the amount of the annual contribution? Assume that the plan assets are expected to earn a 10% return.
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