The Home Improvement Center (HIC) has an employment contract with the newly hired CEO. The contract requires a lump sum payment of $32.4 million be paid to the CEO upon the successful completion of her first five years of service. HIC wants to set aside an equal amount of money at the end of each year to cover this anticipated cash outflow and will earn 7.25% on the funds. How much must HIC set aside each year for this purpose?

Question

Quizplus · Accepted Answer

To find the amount HIC must set aside each year, we use the formula for the future value of an annuity, which is FV = P * [((1 + r)^n - 1) / r], where FV is the future value ($32.4 million), P is the annual payment, r is the annual interest rate (7.25% or 0.0725), and n is the number of periods (5 years). Rearranging the formula to solve for P gives us P = FV / [((1 + r)^n - 1) / r]. Plugging in the values gives P = $32,400,000 / [((1 + 0.0725)^5 - 1) / 0.0725], which calculates to approximately $5,606,026.

The Home Improvement Center (HIC) Has an Employment Contract with the Newly