Question

Our newly constructed retail space is projected to need a face lift in 7 years to keep up with changing tastes. Our projections are that the cost will be $2.5 mil. If we set aside a reserve for replacement our best return prospects for a safe investment (i.e. little risk to principle) suggest a 3% annual interest rate. How much should we deposit annually into that reserve account (sinking fund problem)

Answer 1

Answer:

Annual deposit = $326,265.88

Step-by-step explanation:

The amount to be set aside annually to accumulate $2.5 million in 7 years time ca n be worked out using the future value of an ordinary annuity formula.

The formula is given as follows:

FV = A×( (1+r)^n - 1)/r).

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

FV - Future value

A- annual deposit

n- number of years

r- rate of return

FV - $2.5 million

A- ?

n- 7

A=2,500,000 ÷ (1.03^7 - 1)/0.03 = 326,265.88

Annual deposit = $326,265.88