question archive You have been hired to run a pension fund for Mackay Inc, a small manufacturing firm

You have been hired to run a pension fund for Mackay Inc, a small manufacturing firm

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You have been hired to run a pension fund for Mackay Inc, a small manufacturing firm. The firm currently has $5 million in the fund and expects to have cash inflows of $2 million a year for the first 5 years followed by cash outflows of $ 3 million a year for the next 5 years. Assume that interest rates are at 8%.

i. How much money will be left in the fund at the end of the tenth year?

ii. If you were required to pay a perpetuity after the tenth year (starting in year 11 and going through infinity) out of the balance left in the pension fund, how much could you afford to pay?

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Answer:

PV = FV/(1+r)^n

PV - Present value

FV - Future value

r - Interest rate

n - no. of periods

PV = 5*(1+0.08)^10 + 2*(1+0.08)^9 + 2*(1+0.08)^8 + 2*(1+0.08)^7 + 2*(1+0.08)^6 + 2*(1+0.08)^5 - 3*(1+0.08)^4 -3*(1+0.08)^3 - 3*(1+0.08)^2 - 3*(1+0.08)^1 - 3*(1+0.08)^0 = 10.43

Money in the fund at the end of tenth year = $10.43 million

ii.

Present value of perpetuity is given by = Cashflow/Rate

10.43 = Cashflow/0.08

Cashflow = 0.835 million per year.