As part of your personal budgeting process, you have determined that in each of the next five years you will have budget shortfalls. In other words, you need the amounts shown in the following table at the end of the given year to balance your budget, that is, to make inflows equal outflows.
You expect to be able to earn 8 percent on your investments during the next five years and want to fund the budget shortfalls over these years with a single initial deposit.
|
End of year
|
Budget Shortfall
|
|
1
|
$ 5,000
|
|
2
|
4,000
|
|
3
|
6,000
|
|
4
|
10,000
|
|
5
|
3,000
|
a. How large must the lump-sum deposit into an account paying 8 percent annual interest be today to provide for full coverage of the anticipated budget shortfalls?
b. What effect does an increase in your earnings rate have on the amount calculated in part (a)? Explain.