Suppose that a young couple has just had their first baby and they wish to ensure that enough money will be available to pay for their child's college education. Currently, college tuition, books, fees, and other costs average $12,500 per year
On average, tuition and other costs have historically increased at a rate of 4% per year.
Assuming that college costs continue to increase an average of 4% per year and that all her college savings are invested in an account paying 7% interest, then what is the amount of money she will need to have available at age 18 to pay for all four years of her undergraduate education?
What will be an ideal response?
education?
Answer: This is a two-step problem.
Step 1: Determine the cost of the first year of college.
FV = PV(1 + i)N = $12,500(1.04)18 = $25,322.71
Step 2: Figure out the value for four years of college.
PV of a growing annuity due = C × Image Image (1 + r)
= $25,322.71 × Image (1 + 0.07) = $97,110.01
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