Octavio is 30 years old and earns an annual salary of $55,000. His wife wants to take out a life insurance policy on him until he turns 67. Using the earnings multiple approach, how large should the face value of his insurance policy be--assuming his wife can earn an annual rate of return of 8.5% on his life insurance pay off?

Question

Quizplus · Accepted Answer

Using the earnings multiple approach, the face value of the insurance policy can be calculated as:

Face value = (earnings multiple) x (annual salary) x (years until retirement)

The earnings multiple can be calculated as:

Earnings multiple = (1 + rate of return)^years until retirement

In this case, Octavio's wife wants to insure him until he turns 67, which is 37 years from now. Assuming she can earn an annual rate of return of 8.5% on the life insurance pay off, the earnings multiple is:

Earnings multiple = (1 + 0.085)^37 = 13.272

Plugging this into the face value formula, we get:

Face value = 13.272 x $55,000 x 37 = $223,985

Therefore, the best choice is C.

Octavio Is 30 Years Old and Earns an Annual Salary