What is the optimal consumption during the working years

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Reference no: EM133369174

Case Study: Imagine you just finished 30 years-old, earning $60,000 per year paid at the end of each year. Your salary grows by 3% per year until you retire at the end of age 65 (35 full years of working). After retirement, you are entitled to receive a pension paying 50% of your last salary for the rest of your life (your pension would remain constant). Assume a valuation rate of 5% and a planning horizon to age 95 (30 full years of retirement). Your current subsistent consumption is $20,000 (paid at the end of the year) growing by 2% per year. Assume you have total (net) financial asset of $10,000. Your goal is to maintain a constant discretionary consumption (standard of living) until retirement. Then, during retirement you want to have your discretionary consumption decreased by 1% for the rest of your life. In this question, please ignore income taxes, as well as the many frictions, costs and sources of uncertainty in life.

Questions: Please answer:

Part A: What is the optimal consumption during the working years?

Part B: What fraction of your tenth salary (salary at the end of age 40) should you save to achieve your financial goal? Do not forget subsistent consumption.

Part C: How much financial capital should you have at age 65, so that you can achieve your financial goal. This is also known as your target "retirement nest egg".

Reference no: EM133369174

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