Hello,

I am taking a corporate finance course and am writing a response with the following problem. I have found an answer on course hero which I have attached. In this explanation for the problem there are two charts, and I am having trouble understanding them. I would like to know how they calculated Principal Payment, Interest Payment, and yearly return on both of these charts. Here is the problem that they are answering:

You are an investment advisor and your clients, Marilyn and David, require your services. Marilyn and David are both 65 and are about to retire. They have no assets other than $1,600,000 in cash savings, and they have no debts. They wish to maintain their current lifestyle during their retirement years. Their current annual living expenses are $120,000. They have no children and they do not wish to bequeath any assets to charity (after their death). Marilyn and David are in excellent health and have a normal life expectancy. They are, however, concerned about the possibility of outliving their retirement income (i.e., longevity risk). They will rely entirely on their cash savings to support themselves financially during their retirement years. Furthermore, they have a strong aversion to risk.

Marilyn and David have decided to use their cash savings to purchase an annuity that will provide them with the necessary income to cover their living expenses over their retirement years. They initially consult with Ms. Sheila Young who is an investment advisor at Merrill Lynch about purchasing their desired annuity. Ms. Young is an experienced advisor and claims to be able to get Marilyn and David a much higher annual income than they require because she ?knows? how to invest their savings in financial instruments that can yield at least 15% per year. This rate of return is well above the current and historical average return for U.S. stocks as measured by the S&P 500 index.

Marilyn and David want you to provide a ?second opinion? of the analysis done by the Merrill Lynch advisor. Specifically, they want you to write a memo to Ms. Young that compares her alternative with your "second opinion" and highlights the risks and benefits of each alternative. They feel certain that Ms. Young is not giving due consideration to assumptions and variables that will impact their decision (e.g., market risk, the clients? risk tolerance, life expectancy, among others), but they don?t know how to articulate their concerns to her. Therefore, since you speak ?finance? they would like you to prepare this memo on their behalf.

Assignment

Write a memo to Ms. Sheila Young containing the following information:

• Provide a professional and financially sound critique where you identify the problem(s), if any, with her investment analysis.

• Conduct your own analysis where you address any problem(s) using appropriate methods (e.g., formulas, models, etc.) and assumptions that will help to identify the weaknesses in Ms. Young's approach.

• Recommend one or more specific, clearly explained actions that: 1) address any problem(s) identified with Ms. Young's analysis, and 2) support your specific recommendation(s).

Dear Ms. Sheila Young, I came across your advice given to Mr. David and Marliyn. You told them to invest in the fund where return is more than 15% which is more than return given by S&P. I disagree with your advice because of the following reasons:a) Firstly the investment advice that you have given contains lot of risk as you haven't mentioned the risks carried by such a high return giving fund. b) The clients are not in a situation to face any risks as they total depends on their cash saving for next 20 to 25 years i.e. till the age of 85 or max 90 years of age. As per your advice, the yearly payment that they will get till the age of 90 is much more than their requirement of $120000 as shown below. But the problem with this advice is the risk it carries i.e. in case any downturn they will lose their only support. Current saving Current Annual 1600000 Expenditure Remaining time in Years Return Principal Payment 120000 25 15% $7,519.04 $240,000.0 Interest Payment 0 $247,519.0 Yearly Return 4 years Hence, instead of investing in such a risky fund and get higher return of $247519 per year, its's better to go with fund with much lower risks i.e. where potential of downside is almost nil. Hence, it's better to invest in fund where risk is nil and return is around 6% . In this fund also they can easily get $120000 per year and with no downside risk as given below:Current saving Current Annual 1600000 Expenditure Remaining time in Years Return Principal Payment Interest Payment Yearly Return 120000 25 years 6% $29,162.75 $96,000.00 $125,162.75 Hence, I request you to kindly change your suggestions and please advise them to invest in fund with much lower risks as per my suggestion. Thanking You XYX