Case Study Time Value of Money by AhsanTareen


									                                 Case 3: Kate Myers
                      Basic Concepts: The Time Value of Money

After graduating from Ohio State University with a degree in Finance, Kate Myers took
a position as a stock broker with Merrill Lynch in Cleveland. Although she had several
college loans to make payments on, her goal was to set aside funds for the next eight
years in order to make a down payment on a house. After considering the various
suburbs of Cleveland, Kate chose Lakewood as her desired future residency. Based on
median house price data, she learned that a three-bedroom, two-bath house currently
costs $98,000. To avoid paying Private Mortgage Insurance (PMI), Kate wanted to make
a down payment of 20%.

Because it will be eight years before Kate buys a house, the $98,000 price will surely not
be the same in the future. To estimate the rate at which the median house price will
increase, she considered the historical price appreciation in Lakewood. In the past,
homes appreciated by nearly 4% per annum. Kate was satisfied with this estimation.

Merrill Lynch provides several opportunities for Kate to invest the funds that will be
devoted to the purchase of her future home. She feels that a balanced account
containing stocks, bonds, and government securities would realistically achieve an
annual rate of return of 8%.


    1. Taking into consideration the fact that the $98,000 home price will grow at 4%
         per year, what will be the future median home selling price in Lakewood in
         eight years? What amount will Kate Myers have to accumulate as a down
         payment if she does decide to buy a house in Lakewood?
    2. Based on your answer from number 1, how much will have to be deposited into
         the Merrill Lynch account (which earns 8% per year) at the end of each month
         to accumulate the required down payment?
    3. If Kate decides to make end-of-the-year deposits into the Merrill Lynch account,
         how much would these deposits be? Why is this amount greater than twelve
         times the monthly payment amount?
    4. If homes in Lakewood appreciate by 6% per annum over the next eight years
         instead of the assumed 4%, how much would Kate have to deposit at the end of
         each month to make the down payment? What if the appreciation is only 2%
         per year?
    5. If Kate decided to deposit her down payment funds in less risky certificates of
         deposit (CDs) earning only 4%, how much would she have to deposit at the end
         of each month to make the down payment? What if she pursued a more risky
         investment of growth stocks that have an expected return of 12%?
                                Case 4: Quilici Family
                       Basic Concepts: The Time Value of Money

Greg and Debra Quilici own a four bedroom home in an affluent neighborhood just
north of San Francisco, California. Greg is a partner in the family owned commercial
painting business. Debra now stays home with their child, Brady, who is age 5. Until
recently, the Quilicis have felt very comfortable with their financial position.

After visiting Lawrence Krause, a family financial planner, the couple became
concerned that they were spending too much and not putting enough funds aside for
both their child's future education needs and their own retirement. Greg earns $85,000
per year, but with the rising costs of education, their past contribution efforts have left
them short of their financial goals.

To estimate the amount of money the Quilicis need to begin putting away for future
security some general information was obtained by their financial planner. The couple
felt that the amount of money they currently contribute to their Koegh plan would be
sufficient for their retirement needs. What they had not accounted for was Brady's

Greg is an alumni of Stanford University, a private school with an extremely high
tuition of approximately $20,000 per year. Debra graduated from the University of
North Carolina at Chapel Hill. The tuition expense there is only $2,500 per year. When
Brady turns 18, the couple wishes to send him to either of these exceptional universities.
They have a slight preference for the much more local Stanford University. The
problem, however, is that with the rate at which tuition is increasing the Quilicis are not
sure they can raise enough money.

To assist in the calculations, assume the tuition at both universities will increase at an
annual rate of 5%. Living expenses are currently estimated at $6,000 per year at both
schools. This expense is expected to grow at only 3% per year. Further assume the
Quilicis can deposit their money into a growth oriented mutual fund at Neuberger &
Berman Management, Inc., which has historically earned a 12% return per annum (1%
per month).

The couple wishes to have a pre-determined monthly amount automatically drafted
from their checking account. When Brady starts college they will slowly liquidate the
account by making an annual payment to Brady to cover tuition and living expenses at
the beginning of each year for the four years he will be in college.

    1. How much will be the tuition and living expenses per year when Brady is ready
        to attend? Give an answer for each university.
    2. Once Brady starts college what will his total expenses be in each of his four
        years? Again, give an answer for each university.
    3. How much money will Greg and Debra have to deposit per month to allow
        Brady to attend Stanford University? How much money will have to be
        deposited per month to allow Brady to attend the University of North Carolina?
        (HINT: To answer this question you need to consider the costs of ALL four
    4. What if the Quilicis feel the Neuberger & Berman mutual fund will only yield
        10%. How much will have to be deposited per month in order for Brady to
        attend each college?
    5. What is the relationship between the amount that must be deposited monthly by
        the parents and the future increases in both tuition and living expenses?

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