You are the CFO of the firm Ponce de Leon Foods. The board has decided to...

  

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You are the CFO of the firm Ponce de Leon Foods. The board has decided to offer an early retirement plan whereby the typical 55-year-old worker can retire now with a small cash severance and draw a pension of $10,000 a year, expected to last for 30 years (the first payment would be made one year from now). You plan to set aside sufficient money now to fund the plan and have secured guarantees from your insurance company promising you an 8% annual return on all funds deposited by you, to meet these projected payments based on the terms above, and to bear any risk (such as interest-rate surprises or greater-than-expected lifespans). You expect 100 workers to take advantage of the plan, so you must fund expected pension payouts of $1 million a year for 30 years. The Amalgamated Paper-or-Plastic Workers have objected to the plan, since the pension payments "lose purchasing power" over time due to inflation. They propose an alternative plan of an $8,000 pension (also beginning in a year) that grows each year at a fixed rate of 5%. They claim that this plan should be attractive to the company, since it needs to pay less money to pensioners ($8,000 vs. $10,000) during today's difficult economic times. How much will it cost you for an up-front payment to fund each plan? You are the CFO of the firm Ponce de Leon Foods. The board has decided to offer an early retirement plan whereby the typical 55-year-old worker can retire now with a small cash severance and draw a pension of $10,000 a year, expected to last for 30 years (the first payment would be made one year from now). You plan to set aside sufficient money now to fund the plan and have secured guarantees from your insurance company promising you an 8% annual return on all funds deposited by you, to meet these projected payments based on the terms above, and to bear any risk (such as interest-rate surprises or greater-than-expected lifespans). You expect 100 workers to take advantage of the plan, so you must fund expected pension payouts of $1 million a year for 30 years. The Amalgamated Paper-or-Plastic Workers have objected to the plan, since the pension payments "lose purchasing power" over time due to inflation. They propose an alternative plan of an $8,000 pension (also beginning in a year) that grows each year at a fixed rate of 5%. They claim that this plan should be attractive to the company, since it needs to pay less money to pensioners ($8,000 vs. $10,000) during today's difficult economic times. How much will it cost you for an up-front payment to fund each plan?

Answer rating: 100% (QA)

To determine the upfront payment for each plan we can use the present value formula for an annuity F... View the full answer