FIN 4200 Chapter 7 Homework
Its January 1, 2000 and you are considering your future. Having just turned 30 years old, you are starting
to worry about your retirement. You have always planned on retiring at age 65, despite the fact that life
expectancies have been increasing. You are currently enjoying your job as an executive with a major oil
company making $42,000 per year. Your spouse also works, but makes one-half of your annual salary.
To begin planning for retirement, you must make some assumptions. To begin, you assume that you will
need 80% of your current combined salaries to make ends meet during your golden years. This will have to
be adjusted for inflation, which you expect will average 4% per year for the remainder of your lives. If
necessary, you will spend your retirement working part-time at a fast food restaurant where wages currently
average $6.50 per hour (assume that this will increase at the rate of inflation). You plan on working 20
hours per week and spending the rest of your time working on the house and lawn while chastising the
neighborhood kids for being “lazy good-for-nothing snot-nosed brats who listen to that crazy music and
conspire to ruin your peaceful retirement.” Due to the rapid pace of medical advancements, you expect that
you will live for 40 years beyond retirement, at which point you and your spouse will suffer a mysterious
case of spontaneous combustion resulting in death.
Currently you have made no arrangements for retirement, but you do have a defined contribution plan with
your employer to which you contribute $1200 per year. This money (currently $10,000) is invested in a
diversified portfolio of equity mutual funds, which you expect to earn an average of 12% per year. You
will keep this money in these funds for the next 20 years after which you will become very conservative
and shift it all to bond funds that you expect will earn 7% per year. You spouse has no retirement plan,
though he/she will contribute $2,000 per year (at the beginning of the year) to a tax deferred IRA which
you expect will earn 10% per year. The first contribution will be made one year from today. There will be
no further contributions to either plan after you both retire in 35 years.
At this point, your spouse enters the room and asks what you came up with. Specifically:
1) How much annual income will you need each year during retirement? How much would you need at
retirement to provide this income? Assume that you will earn 7% per year on investments during
2) How much will you have accumulated in each retirement plan on the date of retirement?
3) Will your needs be met from retirement from your current retirement plans? If not, what is the
4) If there is a shortfall, how much additional savings would you need each year if you could earn 10%
per year after taxes? Does this seem feasible given your current income?