At a military base in Texas, Corporal Stan Moneymaker has been offered a wonderful savings plan. These are the salesperson’s words: “During your 48-month tour of duty, you will invest $200 per month for the first 45 months. We will make the 46th, 47th, and 48th payments of $200 each for you. When

Question

At a military base in Texas, Corporal Stan Moneymaker has been offered a wonderful savings plan. These are the salesperson’s words: “During your 48-month tour of duty, you will invest $200 per month for the first 45 months. We will make the 46th, 47th, and 48th payments of $200 each for you. Whenyou leave the service, we will pay you $10,000 cash.” Is this a good deal for Corporal Moneymaker? Use the IRR method in developing your answer. What assumptions are being made by Corporal Moneymaker if he enters into this contract?

Accepted Answer

$10,000 = $200 (F/A, i, 45) (F/P, i, 3) or i per month is approximately
equal to 0.4165% which equates to i per year of (1.004165)[latex]^{12}[/latex] – 1 = 0.0511 (5.11% per year). This is a conservative investment when Stan makes the assumption that the investment firm will pay him $10,000 when he leaves the service at the end of four years (i.e., there is little risk involved). Stan should probably take this opportunity to invest money while he is in the service. It beats U.S. savings bonds which pay about 4% per year.

Question 5.DD: At a military base in Texas, Corporal Stan Moneymaker has be...

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