Question

Ruggiero Brothers Oil has an R85 000 liability it must pay four years from today. The company is opening a savings account, so that the entire amount will be available when this debt needs to be paid. The plan is to make an initial deposit today, and then deposit an additional R16 000 each year for the next four years, starting one year from today. The account pays a 6% rate of return. How much does the firm need to deposit today?

Answer 1

Explanation:

To determine the amount that Buggiero Brothers Oil must deposit today in order to have enough money to pay the R85 000 liability four years from today, we can use the present value formula:

Present Value (PV) = Future Value (FV) / (1 + r)^n

where:

- FV is the future value, which is R85 000

- r is the annual interest rate, which is 6%

- n is the number of years until the liability needs to be paid, which is 4

To calculate the future value of the annual deposits of R16 000, we can use the future value of an annuity formula:

FV = PMT x [(1 + r)^n - 1] / r

where:

- PMT is the annuity payment, which is R16 000

- r is the annual interest rate, which is 6%

- n is the number of years of the annuity, which is 3 (since the first payment is made one year from today)

Plugging in the numbers:

FV = R16 000 x [(1 + 0.06)^3 - 1] / 0.06

FV = R61 719.56

Therefore, the total future value that Buggiero Brothers Oil will have in four years, including the initial deposit and the annual payments, will be:

FV = R85 000 + R61 719.56

FV = R146 719.56

Plugging in the numbers to the present value formula:

PV = R146 719.56 / (1 + 0.06)^4

PV = R116 442.12

Thus, Buggiero Brothers Oil needs to deposit R116 442.12 today to have enough money to pay the R85 000 liability four years from today, assuming a 6% rate of return.