Tutorial 2 (Week 4) Ch02 2.8 Brad and Nerida are considering two alternative investments. Option 1 requires an outlay of $10 000 and after 2 years is expected to bring a cash flow of $1500 p.a. for the next 3 years. Then the investment would be terminated and they would get their $10 000 back. Option 2 requires an outlay of $15 000 and is expected to bring a cash flow of $1200 for each of the next 5 years. They would then expect to sell the investment for $17 500. Explain how net present value calculations would help them to decide on the best investment choice. PROFESSIONAL APPLICATION EXERCISES 2.13 Savings needed ** Wanda wants to accumulate the sum of $30 000 in 3 years when she anticipates using the sum as a deposit on a home unit. She plans to have an annual holiday which she can fund from other savings. She has an initial starting amount of $6000 in an investment fund. If she expects an average annual rate of return of 7% on her investment, how much will she need to save each year for her to reach her objective? 2.16 A savings plan ** Bruce and Karen have a new-born baby, Lisa. Generous grandparents have made a gift of $15 000 available for Lisa. Bruce and Karen have decided to invest this in trust for Lisa so that on her 21st birthday she will have a deposit to buy a one-bedroom home unit. Bruce and Karen are considering making additional annual payments to the trust account, in order to increase the deposit amount to 40% of the expected price of the unit. Assume that the current price of a one-bedroom home unit is $220 000 and that property prices grow at 3% p.a. Assume that the trust account receives interest at 6.5% p.a. (a) What is the projected amount that will be available to Lisa, when she turns 21, from the gift that is being held in trust? (b) How much must Bruce and Karen contribute each year to achieve the desired deposit amount of 40% of the unit’s expected purchase price? 2.19 Paying off a mortgage early *** Caitlin and Troy have settled on buying a new home for $600 000. They have sold their current home for $400 000 and after paying the balance on their first home mortgage have a deposit of $150 000 they can use against the mortgage on their second home. The details of their new home loan are: Repayments Interest Term of the loan Monthly 8.00% (nominal) 20 years p.a. (a) (b) What are Caitlin and Troy’s minimum monthly payments? If they wish to pay their loan off within 12 years, what would be the new amount of the monthly payments in order to achieve their goal? (Assume there are no other changes in the loan conditions.) Mentoring Questions 2.3 An advertisement offers a fixed term deposit for 4 years with an interest rate of 4.8% p.a. compounded annually or a fixed deposit for 4 years with an interest rate of 4.65% p.a. compounded quarterly. Which one would you choose? Explain why. CASE STUDY 1 Assessing a financial situation Albie and Debra are a young married couple who have one child, Noah, aged 3 years. They have plans to send Noah to a private secondary school when he is 12 years of age and have decided to undertake an investment plan so they can pay for the fees from their investments rather than pay the fees from their salaries at that time. They have not yet put into place any savings plans. Albie and Debra are undecided about whether they should invest funds over the next 5 years and then let the investments grow for the remaining 4 years or whether they should wait until Noah is in primary school, when they may be able to afford more money to invest as their salaries should be higher. They are conscious that Debra may not be able to work full-time again until Noah goes to primary school so that is part of the reason why they may not save initially. Hence, they plan to invest $200 per week from now for such a purpose. They know which school they would like to send their children to and have been advised that the fees are $7000 per annum per student. The bursar at the school also advised them that the fees may be expected to rise by 3% per year. Albie and Debra expect to achieve a long-term rate of 6.5% p.a. on their choice of fund, one that is designed for education funding, because of its tax-free status. QUESTIONS 1. Calculate the end benefit if Albie and Debra start investing $200 per week for the next 5 years and then leave the investment intact for the following 4 years. 2. Calculate the alternative approach, which requires them to invest nothing for the next 5 years but then $300 per week for the 4 years prior to Noah commencing secondary school. 3. Explain the difference in terms of the impact of compounding. 4. What other issues do you think they need to consider in their analysis?