Question 4

The City of Oakland has just established a new retirement pension plan for its city government employees and needs answers to the following questions:

1. Oakland contributes $3,000 per year to each city employees retirement pension account and this account earns 6% interest annually. How much would an employee accumulate in his/her retirement pension account at the end of a vesting period of 25 years? Assume all payments are made at the end of the year.

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2. How much money would Oakland have to contribute monthly to an employees retirement pension account in order for the employee to accumulate $150,000 in savings at the end of 25 years. Assume once again that all payments would be made at the end of the month and that the retirement account earns 6% interest annually.

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3. In order to finance its pension plan, Oakland must borrow $500,000 at a 7% annual interest rate and repay the loan in monthly increments of principal and interest over ten years (just like a mortgage). What monthly payment does Oakland make to repay the loan if payments occur at the end of each month?

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Oakland must lease a new facility for administration of its pension plan and has two lease options:

Option A: $100,000 payable at the beginning of each year for the next 20 years.

Option B: $85,000 payable at the end of each year, for the next 20 years plus a lump-sum payment made at the end of 20 years of $18,000.

4. What is the present value cost of Option A using a 5% discount rate?

PV Cost - Option A:

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5. What is the present value cost of Option B using a 5% discount rate?

PV Cost - Option B:

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6. Which lease option is superior from a financial perspective? (circle one)

OPTION A OPTION B

7. Briefly explain why Oakland might prefer to lease rather than buy office space.