W2_Rotimi Ojo_Funding of Child’s Overseas University Education

W2_Rotimi Ojo_Funding of Child’s Overseas University Education

1.    Problem Definition

Determination of how much to put in a savings account paying 6% per annum to finance child’s overseas university education in 12 years time

It is estimated that $13,000 will be required per annum to cover university and other expenses in 12 year time.

Using Time Value of Money Concept and Table C-9^{1} to and deferred annuity concept to estimate amount required just before University education begins

Cash Flow Diagram                                                              A=$13,000.00

P = A (P/A, 6%, 4)

Where P = Present Value at 11^th Year

(P/A, 6%, 4) = Compound Amount Factor from Table C-9 =3.4651

P = 13,000 * 3.4651 = $45,046.30

The result shows that we should have an estimated $45,000.00 to fund my child’s University education a year before he starts university.

2.    Feasible Alternatives

The means available to raise the required funds are

a.    Start investing in an annuity that pays interest at 6% per annum

b.    Find a fixed deposit account that would ensure a return of $45,046.30 11 years from now

3.    Development of Outcome and Cash flows for Alternatives

a.    By investing in an annuity that pays interest at 6% for the next 11 years

Amount to be paid into annuity fund yearly:

F = A (F/A, i, N)

Where F= Future Value of Annuity at year 11

                       I= Interest rate @ 6%

           N= No of periods in which interest payments are made

 

From table C-9^{1}

P₀ = F₁₇ (P/F, i, N) = 45,046.30 * 0.5268 = $2,373.04

I would have to deposit $2,373.04 in this account on the 1^st of January, 2013

b.    Invest in Nigerian Treasury bills paying interest at 12.5% per annum

Using the formula P=     F                  =      45,046.30            =$12,317.98

                                    (1 + i)^N                               (1.125)¹¹              

The result shows that I would have to buy Nigerian Treasury bills worth $12,317.98 on the 1^st of January, 2013 for tenure of 11 years.

4.    Selection Criteria

a)    Risk

b)    Guaranteed returns

c)    Ability to raise initial Capital

5.     Analysis and comparison of alternatives

a)    Alternative A: Investing in annuity, making payments of $2,373.04 per annum for the next 11 years. It carries a higher risk than investing in Government Treasury bills. Returns on investments also bear a level of risk higher than that of the Government’s Treasury bill.

It is relatively easier to come up with $2,373.04 from savings than $12,317.98

b)    Alternative B: Investment in Government Treasury Bills, making a one-off payment of $12,317.98. This option carries a much lower risk and return on investment is almost 100% guaranteed. It is however, a lot more difficult to raise $12,317.98 than to raise $2,373.04

6     Selection of Preferred Alternative

       The preferred alternative is to invest in government treasury bills as it carries a lower risk and returns on investment is more guaranteed. The administrative aspect of the investment is also less cumbersome as it is a one-off event.

       To raise the required amount of $12,317.98, I will apply for an Interest free loan from my company that can be repaid within 18 months (i.e $684.28 monthly payment back to company)

7     Performance Monitoring 

       I shall monitor the performance of my investment by keeping up-to-date with the government’s financial policies and the rate of inflation.

       I will also track the rate of increase in University fees in the United States.

References

Sullivan .G.W, Wicks .E.M &, Koelling C.P (2012), Deferred Annuities Time Value of Money, Engineering Economy (15^th Edition)