Case study 2: Finding Jill Moran’s Retirement Annuity

a. Draw a time line depicting all of the cash flows associated with Sunrise’s view of the
retirement annuity
Answer:

Cash inflow: Accumulation Cash outflow: Distribution Period

period 20 end-of-year payments of $42,000
12 end-of-year deposits; earns balance earns interest at 12%
interest at 9%interest at 9%

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32

End of Year

m
er as
co
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b. How large a sum must Sunrise accumulate by the end of year 12 to provide the 20-year,

o.
$42,000 annuity? rs e
ou urc
Answer:

PVIFA = (1- (1+r)-n)/r

o
aC s

Where:
vi y re

r = Periodic rate per period

n = Number of periods
ed d

PVIFA = (1- (1+0.12)-20)/0.12

ar stu

= 7.4694
Present value of a 20-year ordinary annuity is given by:
is

PVn = PMT × (PVIFAi%,n)

Th

PV20 = $42,000 × (PVIFA12%,20)

PV20 = $42,000 × 7.469
PV20 = $313,698
sh

Therefore, the total amount Sunrise industries have to accumulate by end of year 12 is $313,698.

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 c. How large must Sunrise’s equal annual end-of-year deposits into the account be over the 12-
year accumulation period to fund fully Ms. Moran’s retirement annuity?
Answer: End-of-year deposits at 9% interest:
PMT= FVAn
FVIFAi%,n

FVIFAi,n = (1÷i) × [(1 + i)n – 1]

= (1÷0.09) × [(1 + 0.09)12 – 1]
= 20.141
PMT = $313,698 ÷ (FVIFA9%,12)
PMT = $313,698 ÷ 20.141

m
er as
PMT = $15,575.10

co
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o.
Sunrise Industries is therefore expected to make an annual end-of-year deposit of $15,575.10
rs e
over the 12-year accumulation period to fully fund Ms. Moran with a retirement annuity of
ou urc
$42,000 per year in years 13 to 32.
o

d. How much would Sunrise have to deposit annually during the accumulation period if it could
aC s
vi y re

earn 10% rather than 9% during the accumulation period?

Answer: End-of-year deposits at 10% interest:
PMT = $313,698 ÷ (FVIFA10%,12 yrs.)
ed d
ar stu

PMT = $313,698 ÷ 21.384

PMT = $14,669.75
is

In order to provide Ms. Moran with a retirement annuity of $42,000 a year in years 13 to 32, the
Th

Sunrise Industries will have to make an annual end-of-year deposit of $14,669.75 in years 1–12.
sh

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 e. How much would Sunrise have to deposit annually during the accumulation period if Ms.
Moran’s retirement annuity were a perpetuity and all other terms were the same as initially
described.
Answer:
Initial deposit if the annuity is a perpetuity and the initial deposit earns 9%:
PVIFAi,∞ = 1 ÷ i
PV of Perpetuity = PMT × (1 ÷ i)
PVperp = $42,000 × (1 ÷ 0.12)
PVperp = $42,000 × 8.333
PVperp = $349,986

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er as
End-of-year deposit:

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eH w
PMT = FVAn ÷ (FVIFAi%,n)

o.
FVIFAi,n = (1÷0.09) × [(1 + 0.09)12 – 1]
= 20.141 rs e
ou urc
PMT = $349,986 ÷ (FVIFA9%,12)
o

PMT = $349,986 ÷ 20.141

aC s
vi y re

PMT = $17,376.79

Thus, Sunrise would have to deposit $17,377 annually during the accumulation period if Ms.
ed d
ar stu

Moran 's retirement annuity was a perpetuity and all other terms were the same as initially
presented.
is
Th
sh

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