Holiday Tours (HT)has an employment contract with its newly hired CEO.The contract requires a lump sum payment of $10.4 million be paid to the CEO upon the successful completion of her first three years of service.HT wants to set aside an equal amount of money at the end of each year to cover this anticipated cash outflow and will earn 5.65 percent on the funds.How much must HT set aside each year for this purpose?

Question

Quizplus · Accepted Answer

To find the amount HT must set aside each year, we use the formula for the future value of an annuity. The future value (FV) is $10.4 million, the interest rate (i) is 5.65%, and the number of periods (n) is 3 years. Rearranging the future value of an annuity formula to solve for the annuity payment (PMT) gives us:$$PMT = \frac{FV}{\left[\frac{(1 + i)^n - 1}{i}\right]}$$Plugging in the values:$$PMT = \frac{10,400,000}{\left[\frac{(1 + 0.0565)^3 - 1}{0.0565}\right]}$$$$PMT = \frac{10,400,000}{\left[\frac{(1.0565)^3 - 1}{0.0565}\right]}$$$$PMT = \frac{10,400,000}{3.184467}$$$$PMT ≈ 3,277,973$$Therefore, HT must set aside approximately $3,277,973 each year.

Holiday Tours (HT)has an Employment Contract with Its Newly Hired