1. A recently graduated mechanical engineer wants to build a reserve fund as a safety net to pay his expenses in the unlikely event that he is without work for a short time. His aim is to have $15,000 developed over the next 3 years, with the proviso that the amount has the same purchasing power as $15,000 today. If the expected market rate on investments is 8% per year and inflation is averaging 2% per year, find the annual amount necessary to meet his goal.

The annual amount necessary to meet his goal is $6,049

Explanation:

In order to calculate the the annual amount necessary to meet his goal, first we have to calculate the Inflation adjusted interest rate with the following equation:

Inflation adjusted interest rate = (1+8%)*(1+2%) - 1

Inflation adjusted interest rate = 10.16%

Therefore, to calculate the the annual amount necessary to meet his goal (P) we shall use the following formula:

$15,000 = P*(1-1/1.1016^3)/0.1016

P = $15,000/((1-1/1.1016^3)/0.1016)

P =$6,049

The annual amount necessary to meet his goal is $6,049