Question

Holiday Tours (HT) has an employment contract with its newly hired CEO. The contract requires a lump sum payment of $10.4 million be paid to the CEO upon the successful completion of her first three years of service. HT wants to set aside an equal amount of money at the end of each year to cover this anticipated cash outflow and will earn 5.65 percent on the funds. How much must HT set aside each year for this purpose

Answer 1

HT should set aside each year the sum of $498,279.80

Step-by-step explanation:

This investment scheme that Holiday Tours is considering is known as sinking funds.

A Sinking Fund involves saving a series of equal amount periodically invested at certain rate of interest to accumulate a target amount in the future.

The amount to be deposited periodically can be determined as follows:

A= FV/ ((1+r)^(n) - 1)/n)

A- annual deposit, FV- future value - $10.4 million, r- 5.65%, n- 3

So we can apply this formula as follows:

A = 10,400,000/ (1.0565)^(3)-1)/0.0565

A = 10,400,000/ 20.87180

A= $498,279.80

HT should set aside each year the sum of $498,279.80