Healthy Life is a small health care provider with 125 employees.

Recently, after years of hard work and profitable returns due substantially to their very loyal, hardworking employees, the companys CEO decided to initiate a pension plan as a part of its compensation plan. The plan will start on January 1, 2020.

Each employee covered by the plan is entitled to a pension payment each year after retirement. As required by accounting standards, the controller of the company needs to report the pension obligation (liability). On the basis of a discussion with the supervisor of the Personnel Department and an actuary from an insurance company, the controller develops the following information related to the pension plan.

Average length of time to retirement: 20 years

Expected life duration after retirement 15 years

Total pension payment expected each year after retirement for all employees; payment made at the end of the year: $2,800,000 per year

The interest rate to be used is 8%.

Instructions:

Draw the timeline and determine the present value (PV) of the pension obligation (liability). You can use the Time Value of Money tables from the Knowledge Check or Excel.

Hints:

Step 1 Draw the timeline

Step 2 calculate the PV (present value) of the pension payments at year 20

Step 3 calculate the PV of the figure you calculated in step 1 at year 0. This type of problem is called deferred annuity.