You are the pension fund manager for a consulting company. Your workers will begin to retire...

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You are the pension fund manager for a consulting company. Yourworkers will begin to retire 10 years from now. You estimate thatyou will need $1.2 million exactly 10 years from now to fund thefirst year payments. Due to inflation and growth in the number ofretirees, your annual obligations will grow by 5% per year, andwill continue forever. Your financial advisors tell you that youcan plan on earning 8.0% per year on invested funds. (a) As of now,your company has set aside $12 million to fund its pensionobligations. Is this amount sufficient to meet the obligations?What, specifically, is the amount of the shortfall or excess inpresent value terms? (b) Your company will make annualcontributions (assume end-of-year) to its pension fund to ensurethat it can meet the obligations. These will grow by 5% per year,and will continue forever. What should be the amount of the firstcontribution? Suppose that your advisors revise their assessment ofthe return that you can expect to earn on your invested funds, to7% per year. Note that this is a 12.5% (1/8)reduction in the assumed return. What is thepercentage change in your answer to part (a)? Brieflysummarize the real world issue that this calculationhighlights.

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All financials below are in mn Part a PV of all the future obligations at the end of year 9 PV of a perpetuity with g P R g 12 8 5 40 PV of all obligations today PV at the end of yer 9 x 1 R9 40 See Answer

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Transcribed Image Text

You are the pension fund manager for a consulting company. Yourworkers will begin to retire 10 years from now. You estimate thatyou will need $1.2 million exactly 10 years from now to fund thefirst year payments. Due to inflation and growth in the number ofretirees, your annual obligations will grow by 5% per year, andwill continue forever. Your financial advisors tell you that youcan plan on earning 8.0% per year on invested funds. (a) As of now,your company has set aside $12 million to fund its pensionobligations. Is this amount sufficient to meet the obligations?What, specifically, is the amount of the shortfall or excess inpresent value terms? (b) Your company will make annualcontributions (assume end-of-year) to its pension fund to ensurethat it can meet the obligations. These will grow by 5% per year,and will continue forever. What should be the amount of the firstcontribution? Suppose that your advisors revise their assessment ofthe return that you can expect to earn on your invested funds, to7% per year. Note that this is a 12.5% (1/8)reduction in the assumed return. What is thepercentage change in your answer to part (a)? Brieflysummarize the real world issue that this calculationhighlights.