Reference no: EM132927943

Question - Ajay Sharma (Ajay) and Ankita Sharma (Ankita) had been a happily married for 10 years now. Ajay was placed with one of the top-3 Indian IT companies on the first day of placements. The package and profile was what he had dreamt of. After having worked through various functions and levels for about 13 years successfully, Ajay aged 35 opted to become an entrepreneur by setting up a software firm along with his group of friends. Soon after her graduation, Ankita was also respectably placed. After gaining few years of corporate experience, she took a break from her professional life when blessed with a baby boy, Rohit. Though Rohit turned five now, Ankita continued to be homemaker.

At a time when Ajay decided to be a first-generation entrepreneur, he was also facing a few financial planning dilemmas. Given his fledgling entrepreneurial career and familial requirements, he decided to plan his savings and investments systematically to secure their future. Hence, he had setup few financial goals in his life. He aimed to give the best education to Rohit and wanted him to get his business and double the turnover in the coming 5 years. He was also very specific that he would retire at the age of sixty and hence wanted to do necessary financial planning to lead a hassle-free life post-retirement.

On August 13th 2014, with an open postal cover in his hand, Ajay seemed to be in a very good mood. Ankita was curious to know the reason, Ajay showed her a cheque that he had received from his insurer. Ajay had been paying a premium for a money-back insurance policy for the past few years, and had now received a lump sum amount of '100,000 from its proceeds.

Though he was aware that he would be receiving the lump sum proceeds, he expected it to happen in the coming year. Hence, the cheque came as a pleasant surprise for him.

The moment he saw the cheque the first thing that came to his mind was to spend that money for the much awaited vacation. However, Ankita wanted him to invest the amount in a reasonably good investment avenue. That sounded convincing to Ajay too. When he was on a look out for a good investment avenue, he happened to meet a marketing professional named Ranjit Kalra (Ranjit) who dealt with sales of an array of investment avenues. Ranjit apprised him of a good investment avenue which offered him 10% returns per annum. He also highlighted that the interesting part of the avenue was that there were various options available such as interest can be compounded on an annual or semi-annual or quarterly or even monthly basis. However, Ajay was not very well-versed with financial jargon. Hence, it has put him in a dilemma as to which option would benefit him the best.

Ajay and Ankita had always been planning to allocate money for Rohit's higher studies. But somehow their plans were getting delayed. Rohit was a smart and sharp kid blessed with good grasping power as well as extraordinary learning skills. They wanted to give him the best education by getting him educated in one of the top-notch undergraduate colleges in India. Ajay wished that Rohit would continue their legacy at their alma mater. As per Ajay's knowledge, the average tuition fee in top colleges in India would be around '1 lakh per annum. He expects the fee to increase at an annual rate of 5%. Besides tuition fee, residential students were supposed to pay living/ hostel expenses too. Ajay wanted Rohit to study in a residential institution where he could concentrate on studies without any kind of disturbances. He estimated living expenses to be around '50,000 per annum. Keeping this in mind, he tried to estimate the annual increase in average hostel expenses and arrived at a figure of around 3%. However, he was not clear as to how to arrive at the actual fee that he will have to pay when his son turns eighteen.

Another financial goal of Ajay was to expand his business and double the turnover in another 5 years' time. For this to happen, currently he had to pump in around '20 lakh to setup new offices in two other metro cities. As he didn't have the required funds in hand, he wanted to take finance from a bank at an interest rate of 10% compounded annually for a period of 10 years. He was inquisitive to know about the amount that he was supposed to pay for the funds that he would have borrowed.

Ajay was a man of values and morals. He was very systematic in his approach and was firm about his decisions. He decided to work hard till he reaches 60 years of age after which he wanted to lead a hassle-free retirement life. And he also intends to lead a secured retirement life. He was very specific that he wanted to be financially independent even after his retirement. Hence he made it a point to include this point also in his list of financial goals i.e., creating a retirement corpus in the coming 25 years. He believed that currently he could afford to deposit funds worth '2 lakh per annum in the savings bank which offered 10% per annum. Based on the assumption that his income levels would increase on an annual basis, he wanted to increase the retirement annuity by 5% year-on-year so that he could create a bigger retirement corpus. Ranjit wasn't of much help to Ajay in guiding through his financial planning dilemmas as he could inform him of the avenues but could not give him an apt solution.

Required -

I. What's the significance of Time Value of Money (TMV)? How does it make a difference to financial/investment decisions?

II. How does the power of compounding help investors? How does it help dedicated investors to earn higher returns?

III. In which option should Ajay invest the proceeds of insurance policy to maximize his returns?

IV. How much will be the tuition and living expenses per year when Rohit goes for higher studies? Once Rohit starts college what will be his total expenses in each of his four years? How much money will have to be deposited by Ajay per month to allow Rohit to complete his education from a top-notch institution?

V. How much annuity should be paid by Ajay per annum to repay the loan taken from the bank to expand his business?

VI. How much retirement corpus would be created by Ajay if he sets aside funds worth '2 lakh per annum as well as increase the amount by 5% every year?