Case Study: Bill Smith – Time Value of Money
While there are many uses for the “problem solving” skills required to complete this assignment, the following article provides a background for this assignment:
Here’s How Much the Average American Has Saved for Retirement, https://smartasset.com/retirement/average-retirement-savings-are-you-normal
Solve the following case scenario problem using the data given.
You will find that using a spreadsheet program like Excel, or a financial calculator to be extremely useful.
Tip: If using Excel go to Financial > Formulas.
Consider designing the spreadsheet to analyze each respective year’s cash requirements versus cash inflows, and then analyze the shortfall in each year on a “present value” basis.
To ease computations, assume the cash flow shortfall occurs at the end of each calendar year of Bill’s retirement.
Case Study and Questions
Your client, Bill Smith engages you to assist him in planning for his retirement.
Specifically, he wants the following question answered:
In addition to the amounts described below, how much money will I need to invest at the end of each of the next three years (i.e., December 2021, 2022 and 2023), invested at 4.0% (compounded annually), so I may retire at my desired standard of living at the end of three years from now (December 31, 2023)?
Assume today is January 1, 2021 and ignore the impact of income taxes throughout.
In order to answer Bill’s question, you gather the following information from him:
Bill desires an income in today’s dollars of $90,000 during each year of his retirement, which is assumed to last 16 years.
One of Bill greatest concerns is inflation. He recently read inflation is expected to average 2.5% annually over the next twenty years. Thinking about the impact of inflation, remember that to maintain $1 in purchasing power, $1.025 would be required next year if inflation was 2.5%.
Bill will be eligible for Social Security. Assuming Social Security benefits increase 2% per year as they have in the past, Bill would receive $24,500 in the first year of retirement, increasing thereafter at the historical rate (2%).
Bill has been told by his employer that at December 31, 2023 he will be eligible for a fixed pension of $32,000 per year (beginning in 2024). This pension is fixed and does not increase in subsequent years.
Bill currently has $20,000 in a certificate of deposit account earning 2% compounded annually which matures on his retirement date. He states that these funds will be made available to support his retirement savings pool as of the date of his retirement (at which time these funds will be combined with the account set up for his three annual payments and will begin earning the higher rate of return).
In addition to the answer to his question, Bill asks that you provide sufficient detail so he may review and understand your analysis.
For Further Thought
Not required but for your further thought (when you have more time….):
Assume Bill is much younger and wants to retire in 25 years, how much does he need to set aside in each of the next 25 years to meet his goal? Assume his retirement lasts 16 years and other facts above still apply as of the date of his retirement.
Bill’s employer provides a pension of $32,000 per year, what amount of money does the Company need to have set aside at his retirement date to provide this benefit assuming the funds earn 4% per year? What is the amount required to be set aside if the funds earn 7% versus 4%?