Assignment

#1 Question 10 (15 points) Christine is a new homebuyer. She wants to make sure that she incorporates the cost of maintenance into her decision. She estimates that routine repairs and maintenance on the home she is considering will be $1,590 in the first year (one year from now). Due to the increasing age of the home, she expects that maintenance costs will increase 6% annually. The interest rate is 5%. If she plans to be in the home for 10 years, what is the present value of all future maintenance? (Note that maintenance costs will change annually, and starts one year from now and she plans to do the last one before selling her house.) As with all problems, I always like to start with a timeline to visualize the question:

Maintenance payments grow at 6% per year

T=0

T=1

T=10

Today First maintenance payment of $1590

Interest rate =5%

Final maintenance payment (end of time in house)

In this question, we are trying to find the PRESENT VALUE of the total maintenance payments that Christine is making over the next 10 years. What makes the problem tricky is that the amount of the maintenance payment grows each year. So we have to use multiple steps to solve the problem. The first step is to forecast the maintenance payments in EACH of the next ten years, using the given growth rate of 6%. You should have ten separate numbers, each one 6% greater than the previous years figure. For the second step, you can choose to go in 1 of 2 directions. Option 1 is to find the future value in year 10 of each of these maintenance payments. You can use the excel FV function (careful to use the correct value for r) to find the value IN YEAR 10 of each of these maintenance payments. Then you can sum them up, and discount that value back to time T=0. Option 2 is to discount each of the maintenance payments found in the first step back to time T=0. You can do this using the excel PV function (again careful to use the correct value for r). Once you have each of the 10 values in year 0 terms, you simply have to sum them up to find the total present value of the maintenance payments.