Emily Dao, 27, just received a promotion at work that increased her annual salary to $37,000. She is eligible to participate in her employer’s 401(k) retirement plan in which the employer matches, dollar for dollar, workers’ contributions up to 5 percent of salary. However, Emily wants to buy a new $25,000 car in three years, and she wants to have enough money to make a $7,000 down payment on the car and finance the balance. Fortunately, she expects a sizable bonus this year that she hopes will cover that down payment in three years.
A wedding is also in her plans. Emily and her boyfriend, Paul, have set a wedding date two years in the future, after he finishes medical school. In addition, Emily and Paul want to buy a home of their own as soon as possible. This might be possible because at age 30, Emily will be eligible to access a $50,000 trust fund left to her as an inheritance by her late grandfather. Her trust fund is invested in 7 percent government bonds.
- Justify Emily’s participation in her employer’s 401(k) plan using the time-value-of-money concepts by explaining how much an investment of $10,000 will grow to be in 40 years if it earns 10 percent.
- Calculate the amount of money that Emily needs to set aside from her bonus this year to cover the down payment on a new car, assuming she can earn 6 percent on her savings. What if she could earn 10 percent on her savings?
- What will be the value of Emily’s trust fund at age 60 if she takes possession of half of the money ($25,000 of the $50,000 trust fund) at age 30 for a house down payment and leaves the other half of the money untouched where it is currently invested?
- What is the relationship between discounting and compounding?
- List at least two actions that Emily and Paul could take to accumulate more for their retirement (think about interest rate or number of year)
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