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December 19, 2014

December 19, 2014

Posted by **Diane** on Tuesday, December 21, 2010 at 8:31am.

As a financial planner a client comes to you for investment advice. After meeting with him and understanding his needs, you offer him the following two investment options:

Option 1 (refer to section on Mathematics of Finance in your text.): Invest $23,000 in a savings account at 4.25% interest compounded quarterly.

Option 2 (refer to section on Mathematics of Finance in your text): Invest into an ordinary annuity where $5,000 is deposited each year into an account that earns 6.6% interest compounded annually.

- Business Algebra -
**drwls**, Tuesday, December 21, 2010 at 9:35amAre you supposed to compare the relative merits of these options? The value of an annuity depends upon the actuarial probability of different expected life spans (expected number of payouts), and upon when the payouts begin. At death, the value of an annuity is zero.

Expected life span depends upon the age, sex, smoking history, obesity and general health (pre-existing conditions) of the individual.

Anyway, you have not asked a question yet and we do not have access to your text.

- Business Algebra -
**Diane**, Tuesday, December 21, 2010 at 9:48amYes. I just don't know how to do them. I have tried and would just like some help please. Thanks

- Business Algebra -
**Diane**, Tuesday, December 21, 2010 at 9:53amNow, I have the formula's I am to use and just can't figure out if it is correct.

Quarterly = P (1 + r/4)4 = (quarterly compounding)

$23,000 (1+0.0425/4) 4 = $28,994.38

Annually = P × (1 + r) = (annual compounding)

$5,000 x (1+0.066) = $5,330

Is this correct?

- Business Algebra -
**Diane**, Tuesday, December 21, 2010 at 9:57amThen I have to use a worksheet and I have no clue how to do this one.

SPREADSHEET:

Set up the formula for compound interest for Option 1 and the formula for Future Value of an Annuity for Option 2 in an Excel spreadsheet to calculate the amount earned at the end of 5 years. Be sure to label all variables in your spreadsheet. Be sure to upload your spreadsheet for formula verification.

- Business Algebra-more help needed -
**drwls**, Tuesday, December 21, 2010 at 10:00amYou seem to be on the right track. We appreciate the feedback.

This is not my field of expertise but one of our other teachers might be able to help.

- Business Algebra -
**Dr Russ**, Tuesday, December 21, 2010 at 10:06amTaking option 1 from first principles

At time 0 there is $23000

after quarter 1 there is $23000x(1.0425)

after quarter 2 there is $23000x(1.0425)x1.0425

after quarter n there is $23000x(1.0425)^n

With option 2

at time zero there is $5000

after year 1 there is $5000x1.066+$5000

after year 2 there is $5000x1.066x1.066+$5000+45000

after year n there is $5000x(1.066)^n+$5000x(n)

I am not quite sure what you plan to do with these. Initially option 2 is the better, but after about 25 years Option is better. You need to plot these to decide, or solve mathematically.

- Business Algebra -
**Dr Russ**, Tuesday, December 21, 2010 at 10:10amIn the question Option 1 does not state annual interest which your formula implies.

And from my post

after year 2 there is $5000x1.066x1.066+$5000+45000

should be

after year 2 there is $5000x1.066x1.066+$5000+$5000

- Business Algebra -
**Diane**, Tuesday, December 21, 2010 at 10:49amI got it now. I understand. Thanks so much for your help. Perfect!!!

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