What will your portfolio be worth in 10 years? In 20 years? When you stop working? The Human Resources Department at Tri-State Corporation was asked to develop a fnancial planning model that would help employees address these questions. Tom Gifford was asked to lead this effort and decided to begin by developing a fnancial plan for himself. Tom has a degree in business and, at the age of 25, is making $34,000 per year. After two years of contributions to his companys retirement program and the receipt of a small inheritance, Tom has accumulated a portfolio valued at $14,500. Tom plans to work 30 more years and hopes to accumulate a portfolio valued at $1,000,000. Can he do it? Tom began with a few assumptions about his future salary, his new investment contributions, and his portfolio growth rate. He assumed 5% annual salary growth rate as reasonable and wanted to make new investment contributions at 4% of his salary. After some research on historical stock market performance, Tom decided that a 10% annual portfolio growth rate was reasonable. Using these assumptions, Tom developed the Excel worksheet shown in Figure 12.18. Toms specifc situation and his assumptions are in the top portion of the worksheet (cells D3:D8). The worksheet provides a fnancial plan for the next fve years. In computing the portfolio earnings for a given year, Tom assumed that his 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. Using Figure 12.18, we see that at age 29, Tom is projected to have a portfolio valued at $32,898. Toms plan was to use this worksheet as a template to develop fnancial plans for the companys employees. The assumptions in cells D3:D8 would be different for each employee, and rows would be added to the worksheet to refect the number of years appropriate for each employee. After adding another 25 rows to the worksheet, Tom found that he could expect to have a portfolio of $627,937 after 30 years. Tom then took his results to show his boss, Kate Riegle.

Although Kate was pleased with Toms 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. 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 Tom to account for the random variability in the salary growth rate and the portfolio growth rate. After some research, Tom and Kate decided to assume that the annual salary growth rate would vary from 0% to 10% and that a uniform probability distribution would provide a realistic approximation. Tri-States accounting frm suggested that the annual portfolio growth rate could be approximated by a normal probability distribution with a mean of 10% and a standard deviation of 5%. With this information, Tom set off to develop a simulation model that could be used by the companys employees for fnancial planning. Managerial Report Play the role of Tom Gifford and develop a simulation model for fnancial planning. Write a report for Toms boss and, at a minimum, include the following: 1. Without considering the random variability in growth rates, extend the worksheet in Figure 12.18 to 30 years. Confrm that by using the constant annual salary growth rate and the constant annual portfolio growth rate, Tom can expect to have a 30-year portfolio of $627,937. What would Toms annual investment rate have to increase to in order for his portfolio to reach a 30-year, $1,000,000 goal? 2. Incorporate the random variability of the annual salary growth rate and the annual portfolio growth rate into a simulation model. Assume that Tom is willing to use the annual investment rate that predicted a 30-year, $1,000,000 portfolio in part 1. Show how to simulate Toms 30-year financial plan. Use results from the simulation model to comment on the uncertainty associated with Tom reaching the 30-year, $1,000,000 goal. Discuss the advantages of repeating the simulation numerous times. 3. What recommendations do you have for employees with a current profile similar to Toms after seeing the impact of the uncertainty in the annual salary growth rate and the annual portfolio growth rate? 4. Assume that Tom is willing to consider working 35 years instead of 30 years. What is your assessment of this strategy if Toms goal is to have a portfolio worth $1,000,000? 5. Discuss how the financial planning model developed for Tom Gifford can be used as a template to develop a financial plan for any of the companys employees.