with workings and explanation
John is looking at several options to fund his son’s 4-year university degree.
The university fees of $45,000 a year will have be paid starting 11 years from today. He is analysing an insurance plan that pays out $45,000 a year for 4 years with the first payout 11 years from today. The insurance plan has several payment options:
Option 1
Pay $60,000 today.
Option 2
Beginning 1 year from today, pay $12,000 a year for the next 8 years.
Option 3
Beginning 1 year from today, make payments each year for the next 8 years. The first payment is $11,000 and the amount increases by 5% each year.
Answer the following questions regarding the options above:
(a) Calculate the present value of each option. Use a 10% discount rate.
(b) Analyse which option John should choose.
(c) If the discount rate is not given to you, what would be an appropriate discount rate to use?
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