Project MBA Business Environment
Bob and Carol are planning for the birth of their first child exactly four years from today. They are now ready to start their savings plan for the big event. The current hospital cost for having a healthy baby at the local hospital is $6500 after all insurance payments. Pre-natal care for the immediate 12-month period prior to having the baby amounts to $2000 in out-of-pocket costs. Carol's best friend is planning a baby shower, so only a crib, a baby carrier, and other miscellaneous items will be needed, which all cost $1,200 today. However, these items will be purchased and paid for on the day of the child’s birth, and the items are expected to increase in costs by 10% each year over the next four years due to inflation.
Bob and Carol now have $500 in cash that they plan to put in the bank in order to cover all the new costs. Also, Uncle Ted has promised to contribute $1000 at the end of year two, as a present to Bob and Carol for baby expenses.
Currently, Bob and Carol can earn 6% compounded annually on this money. In order to be able to pay cash for all these expenses on the day the baby is born, how much will Bob and Carol have to save, assuming the baby is born exactly four years from today
Questions:
Draw the timeline that illustrates the timing of all the events of the situation described above.
How much will Bob and Carol need to have in the bank on the day the baby is born in order to achieve all their goals?
What amount needs to be saved at the end of each year in order for Bob and Carol to reach their financial goals?
How much will Bob and Carol need to have in the bank on the day the baby is born?: In order for Bob and Carol to be able to pay cash for all these expenses, they will need to have a total of $10,743.34 saved up four years from today. This includes the hospital costs ($6500), pre-natal care ($2000), items needed at birth ($1,200 x 1.46 =$1752) plus interest earned over time (6% * 500=$30).
What amount needs to be saved at the end of each year?: At the end of Year One, Bob and Carol must have saved an additional $1,800 (in addition to their initial deposit). By Year Two this amount increases by another thousand dollars (due to Uncle Ted’s contribution) so it should be at least $2,800; by Year Three this number goes up again with added inflationary costs so it should reach around $3,820; finally at Year Four when their new baby arrives this figure spikes once more due largely in part towards buying those remaining necessities so now its total comes out as being around $5,074.02!