question is driving me a little nutz she, avid, permission, beginning, equipment

AnalystAlan

Elise Corrs, hedge fund manager and avid downhill skier, was recently granted permission to take a 4 month sabbatical. During the sabbatical, (scheduled to start in 11 months), Corrs will ski at approximately 12 resorts located in the Austrian, Italian, and Swiss Alps. Corrs estimates that she will need $6,000 at the beginning of each month for expenses that month. (She has already financed her initial travel and equipment costs.) Her financial planner estimates that she will earn an annual rate of 8.5 percent during her savings period and an annual rate of return during her sabbatical of 9.5 percent. How much does she need to put in her savings account at the end of each month for the next 11 months to ensure the cash flow she needs over her sabbatical? Each month, Corrs should save approximately:
A) $2,065.
B) $2,070.
C) $2,180.
D) $2,080.
–
So, in order to do this problem, we’re first going to have to calculate the present value of money needed at the beginning of the 4 month sabbatical, and then calculate how much we would need to save to get to that.
This is how Schweser claims we find out the present value of money needed at the beginning of the 4 month sabbatical:
Step 1: Calculate present value of amount required during the sabbatical
Using a financial calculator: Set to BEGIN Mode, then N = 4, I/Y = 9.5 / 12 = 0.79167, PMT = 6,000, FV = 0, Compute PV = 23,719.
My question is why are we dividing 9.5 by 12? It’s already an annual rate so we’re not annualizing it. They do this again for the second part:
Step 2: Calculate amount to save each month
Using a financial calculator: Make sure it is set to END mode, then N = 11, I/Y = 8.5 / 12.0 = 0.70833, PV = 0, FV = 23,719 Compute PMT= 2,081, or approximately $2,080.
WHY ARE THEY DIVIDING THE INTEREST RATE BY 12?

kseniaru

Because the time periods in question here are a month long. If you didn’t divide by twelve, the calculator would grow (or discount) the monthly cash flows at the annual rates of 8.5% or 9.5%. If the time periods were quarters, you’d divide the annual interest rates by 4, semiannual by 2, etc…

badonkus

In order to get monthly interest rate.
And yes. First compute money needed at the begining of her skiing holidays. This ammount is the future value when computing monthly payments needed to save this amount.
Be carefull with bgn/end mode on your calculator. And different interest rates as well……

noel

ok, the I/Y has to be in line with the N time period. thanks guys you rock. =)