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Chapter V.

Time value of money.

Sandra Gilbert, she’s 65 years old next year and she’s getting ready to retire. She worked at Wolfson Industries as an accountant and quality control engineer over the past 25 years and Sandra managed to raise $400,000 in her retirement account. Her husband died two years ago at the age of 70 and had no offspring. Jack Eloster from the Human Relations Department visited Sandra in anticipation of her retirement. Make it clear that there are a number of options you can make.

Four options:

1. The first option was to take a full $400,000 when she retired next year. She can then take the money and invest it herself. She’ll be in a 35 per cent tax chip and she’ll have to pay this rate at $400,000 before she can invest her money.

2. Sandra’s life expectancy is another 20 years, and you can receive an annual salary of $35,000 per year over the next 20 years. Considering that her annual income will be relatively small, a 15 per cent tax rate will be applied.

3. Seeing as it’s mostly over the age of males, one of the financial planning experts suggested that 90 would be the average life expectancy. That means she expects to live another 25 years. Under this scenario, Sandra can be expected to receive $31,000 a year and pay taxes at a rate of 15 per cent.

4. The fourth and final option would be to take half of the $400,000 initially and the balance Sandra gets in the form of annual equal payments over the next ten years. The tax rate for the initial payment will be 35 per cent and 15 per cent for subsequent payments.

There may be many other options for withdrawing $400,000, but Sandra preferred to consider these options for the time being.

Wanted: 1. Count the present value after deduction of the tax for option one. 2 .Assuming a discount rate of 8 per cent, the net present value of the tax benefits of option 2 is calculated. 3 .Again assuming a discount rate of 8 per cent, calculate the net present value of the tax benefits of option 3. 4 .What is the net present value of option 4 based on the established tax rates and 8% discount ratio? 5 .Which of the four options provides the highest current net value? 6. When comparing options 2 and 3, if a discount rate of 4 per cent is used instead of 8 per cent, will your answer change? Explain the reason for your conclusion.