Homework Assignment 2 (8 marks) (individual Work)
1. Suppose you are 40 years old and plan to retire in exactly 20 years. 21 years from now you will need to withdraw $5,000 per year from a retirement fund to supplement your social security payments. You expect to live to the age of 85. How much money should you place in the retirement fund each year for the next 20 years to reach your retirement goal if you can earn 12% interest per year from the fund? (3 Marks)
2. Assume that a particular firm has a total asset of $200 million and it has to choose a financing scheme among three ones. The description of these schemes is given below.
- Scheme 1: Borrowing today a unique amount equal to 25% of the total assets value. This borrowed amount will be paid off at the end of year 5 and the interests charges will be based on a 5.25% yearly fixed interest rate.
- Scheme 2: Borrowing today a unique amount equal to 25% of the total assets value. The banker offered the firm a fully amortizing for 5 years at a 5.25% annual rate. The payment should be paid at the end of each year.
- Scheme 3: Borrowing at the end of each year 5% of the of the total assets value (i.e., borrow $10 million at the end of each year for 5 years). The total borrowed amount will be paid off at the end of year 5 and the interests charges will be based on an annual 4.25% fixed interest rate.
What would you recommend to the CFO (Chief Financial Officer) if we suppose that he has concern about the cost of borrowing and that he would choose the financing scheme that minimizes the amount of interest paid on the financing period? Document your computations and findings. (5 Marks)