ordinary annuity

Question

Pat and Joe are divorced. The divorce settlement stipulated that Joe pay $525 a month for their daughter until she turns 18 in four years. How much must Joe set aside today to meet the settlement? Interest is 6% a year. ___

Answer 1

Basically, we want to know how much he should set aside so that it earns enough interest in 4 years to cover the total amount owed.  If he pays 525 a month for 4 years, he will ultimately owe 525 x 4 x 12 or 25200.

 

Yearly interest is calculated using the formula I = Prt where I is interest, P is principle (original investment), r is annual rate (as a decimal) and t is time (in years).  So the interest he earns on any principle P he invests will be P x 0.06 x 4 or 0.24P.

 

Since he will also have the principle P to draw upon, Principle + Interest = Amount Owed.

 

Therefore, 

P + 0.24P = 25200

1.24P = 25200

P = 20322.58

 

He will need to set aside 20322.58 to meet the obligation.