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Chapter 5, Solutions        Cornett, Adair, and Nofsinger

Rate of return

7%

Inflation rate

3.8%

Average effective tax rate

22.6%

2. Retirement years

Retirement age

65 years

Life expectancy

85 years

Estate amount

$0

Using a financial calculator, the following inputs are needed to determine the projected annual payment:

n = 20 years

i = 1.07/1.038 -1 = 3.083%

PV = $1,000,000

CPT PMT = $67,732.56  (The calculator rounds this amount to the nearest $10,000 for an estimate of $70,000 gross annually.)

Integrated Mini Case:  Paying on your Stafford loan

Consider Gunther, a new freshman who has just received a Stafford student loan and started college.  He plans to obtain the maximum loan from Stafford at the beginning of each year.  Although Gavin does not have to make any payments while he is in school, the 6.8 percent interest owed (compounded monthly) accrues and is added to the balance of the loan.

Stafford loan limits:

Freshman$2,625

Sophomore$3,500

Junior$5,500

Senior$5,500

After graduation, Gavin gets a six month grace period.  This means that monthly payments are still not required, but interest is still accruing. After the grace period, the standard repayment plan is to amortize the debt using monthly payments for 10 years.

a. Show a time line of when the loans will be taken.

b. What will be the loan balance when Gavin graduates after his fourth year of school?

c. What is the loan balance six months after graduation?

d. Using the standard repayment plan and a 6.8 percent APR interest rate, compute the monthly payments Gavin owes after the grace period.

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