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Case Study 4: The HR Department at FunTravel Company is developing a financial planning model that would assist employees to address questions such as What will your investment portfolio be worth in 10 years? When you stop working? Joyce Springfield is given a task to lead this effort. She has started by developing a financial plan for herself. She has a bachelor degree in business information systems and, at the age of 40, is making $85,000 per year. Through contributions to her company's retirement program and the receipt of a small inheritance, she has accumulated a portfolio valued at $50,000. She plans to work 20 more years and hopes to accumulate a portfolio valued at $1,500,000. Can she do it? Joyce began with a few assumptions about her future salary, her new investment contributions, and her portfolio growth rate. She assumed a 5% annual salary growth rate and plans to make new investment contributions at 6% of her salary. After some research on historical stock market performance, Joyce decided that a 10% annual portfolio growth rate is reasonable. Using these assumptions, Joyce developed the following Excel worksheet: D E F G A FunTravel Age Current Salary Current Portfolio Annual Investment Rate Salary Growth Rate Portfolio Growth Rate 40 $85,000 $50,000 6% 5% 10% Year 1 Age 41 42 2 3 4 Beginning Balance Salary New Investment Earnings Ending Balance $50,000 $85,000 $5,100 $5,255 $60,355 $60,355 $89,250 $5,355 $6,303 $72,013 $72,013 $93,713 $5,623 $7,482 $85,118 $85,118 $98,398 $5,904 $8,807 $99,829 $99,829 $103,318 $6,199 $10,293 $116,321 || 43 44 45 5 The worksheet provides a financial projection for the next five years. In computing the portfolio earnings for a given year, Joyce assumed that her new investment contribution would occur evenly throughout the year, and thus half of the new investment could be included in the computation of the portfolio earnings for the year. From the worksheet, we see that, at age 45, she is projected to have a portfolio valued at $116,321. Joyce's plan was to use this worksheet as a template to develop financial plans for the company's employees. The data in the spreadsheet would be tailored for each employee, and rows would be added to it to reflect the employee's planning horizon. After adding another 15 rows to the worksheet, Joyce found that she could expect to have a portfolio of $772,722 after 20 years. Joyce then took her results to show her manager, Ai Zhou. Although Ai was pleased with Joyce's progress, she voiced several criticisms. One of the criticisms was the assumption of a constant annual salary growth rate. She noted that most employees experience some variation in the annual salary growth rate from year to year for example last year the impact of Covid pandemic (economic slowdown) forced some employees to take pay cuts. In addition, she pointed out that the constant annual portfolio growth rate was unrealistic and that the actual growth rate would vary considerably from year to year. She further suggested that a simulation model for the portfolio projection might allow Joyce to account for the random variability in the salary growth rate and the portfolio growth rate. After some research, Joyce and Ai decided to assume that the annual salary growth rate would vary from 0% to 8% and that a uniform probability distribution would provide a realistic approximation. FunTravels' accountants suggested that the annual portfolio growth rate could be approximated by a normal probability distribution with a mean of 7% and a standard deviation of 3%. With this information, Joyce set off to redesign her spreadsheet so that it could be used by the company's employees for financial planning. Your Tasks: You have been asked to help Joyce Springfield develop a simulation model for financial planning. Write a report for Joyce's manager and, at a minimum, include the following: 5 a. Without considering the random variability, extend the current worksheet to 20 years. Confirm that by using the constant annual salary growth rate and the constant annual portfolio growth rate, Joyce can expect to have a 20-year portfolio of $772,722. What would Joyce's annual investment rate have to increase to in order for her portfolio to reach a 20-year, $1,500,000 goal? (Hint: Use Goal Seek.) b. Redesign the spreadsheet model to incorporate the random variability of the annual salary growth rate and the annual portfolio growth rate into a simulation model. Assume that Joyce is willing to use the annual investment rate that predicted a 20-year, $1,500,000 portfolio in part 1. Show how to simulate Joyce's 20-year financial plan. Use results from the simulation model to comment on the uncertainty associated with Joyce reaching the 20-year, $1,500,000 goal. c. In the midst of Covid pandemic, what recommendations do you have for employees with a profile similar to Joyce's after seeing the impact of the uncertainty in the annual salary growth rate and the annual portfolio growth rate? d. Joyce is considering to work for 5 more years beyond her initial retirement year. What is your assessment of this strategy if Joyce's goal is to have a portfolio worth $1,500,000? e. Could Joyce's model be employed by staff members of other companies? If yes, why? if no, then what adjustment would other staff need to make. Case Study 4: The HR Department at FunTravel Company is developing a financial planning model that would assist employees to address questions such as What will your investment portfolio be worth in 10 years? When you stop working? Joyce Springfield is given a task to lead this effort. She has started by developing a financial plan for herself. She has a bachelor degree in business information systems and, at the age of 40, is making $85,000 per year. Through contributions to her company's retirement program and the receipt of a small inheritance, she has accumulated a portfolio valued at $50,000. She plans to work 20 more years and hopes to accumulate a portfolio valued at $1,500,000. Can she do it? Joyce began with a few assumptions about her future salary, her new investment contributions, and her portfolio growth rate. She assumed a 5% annual salary growth rate and plans to make new investment contributions at 6% of her salary. After some research on historical stock market performance, Joyce decided that a 10% annual portfolio growth rate is reasonable. Using these assumptions, Joyce developed the following Excel worksheet: D E F G A FunTravel Age Current Salary Current Portfolio Annual Investment Rate Salary Growth Rate Portfolio Growth Rate 40 $85,000 $50,000 6% 5% 10% Year 1 Age 41 42 2 3 4 Beginning Balance Salary New Investment Earnings Ending Balance $50,000 $85,000 $5,100 $5,255 $60,355 $60,355 $89,250 $5,355 $6,303 $72,013 $72,013 $93,713 $5,623 $7,482 $85,118 $85,118 $98,398 $5,904 $8,807 $99,829 $99,829 $103,318 $6,199 $10,293 $116,321 || 43 44 45 5 The worksheet provides a financial projection for the next five years. In computing the portfolio earnings for a given year, Joyce assumed that her new investment contribution would occur evenly throughout the year, and thus half of the new investment could be included in the computation of the portfolio earnings for the year. From the worksheet, we see that, at age 45, she is projected to have a portfolio valued at $116,321. Joyce's plan was to use this worksheet as a template to develop financial plans for the company's employees. The data in the spreadsheet would be tailored for each employee, and rows would be added to it to reflect the employee's planning horizon. After adding another 15 rows to the worksheet, Joyce found that she could expect to have a portfolio of $772,722 after 20 years. Joyce then took her results to show her manager, Ai Zhou. Although Ai was pleased with Joyce's progress, she voiced several criticisms. One of the criticisms was the assumption of a constant annual salary growth rate. She noted that most employees experience some variation in the annual salary growth rate from year to year for example last year the impact of Covid pandemic (economic slowdown) forced some employees to take pay cuts. In addition, she pointed out that the constant annual portfolio growth rate was unrealistic and that the actual growth rate would vary considerably from year to year. She further suggested that a simulation model for the portfolio projection might allow Joyce to account for the random variability in the salary growth rate and the portfolio growth rate. After some research, Joyce and Ai decided to assume that the annual salary growth rate would vary from 0% to 8% and that a uniform probability distribution would provide a realistic approximation. FunTravels' accountants suggested that the annual portfolio growth rate could be approximated by a normal probability distribution with a mean of 7% and a standard deviation of 3%. With this information, Joyce set off to redesign her spreadsheet so that it could be used by the company's employees for financial planning. Your Tasks: You have been asked to help Joyce Springfield develop a simulation model for financial planning. Write a report for Joyce's manager and, at a minimum, include the following: 5 a. Without considering the random variability, extend the current worksheet to 20 years. Confirm that by using the constant annual salary growth rate and the constant annual portfolio growth rate, Joyce can expect to have a 20-year portfolio of $772,722. What would Joyce's annual investment rate have to increase to in order for her portfolio to reach a 20-year, $1,500,000 goal? (Hint: Use Goal Seek.) b. Redesign the spreadsheet model to incorporate the random variability of the annual salary growth rate and the annual portfolio growth rate into a simulation model. Assume that Joyce is willing to use the annual investment rate that predicted a 20-year, $1,500,000 portfolio in part 1. Show how to simulate Joyce's 20-year financial plan. Use results from the simulation model to comment on the uncertainty associated with Joyce reaching the 20-year, $1,500,000 goal. c. In the midst of Covid pandemic, what recommendations do you have for employees with a profile similar to Joyce's after seeing the impact of the uncertainty in the annual salary growth rate and the annual portfolio growth rate? d. Joyce is considering to work for 5 more years beyond her initial retirement year. What is your assessment of this strategy if Joyce's goal is to have a portfolio worth $1,500,000? e. Could Joyce's model be employed by staff members of other companies? If yes, why? if no, then what adjustment would other staff need to make