Question

In Exercises, determine the principal \(P\) that must be invested at interest rate \(r\), compounded continuously, so that \(\$ 1,000,000\) will be available for retirement in \(t\) years. $$ r=10 \%, t=25 $$

Short answer

The initial amount (principal) that needs to be invested, compounded continuously at an interest rate of 10%, in order to have $1,000,000 at retirement in 25 years, can be calculated using the formula for continuously compounded interest: \(P = A / e^{rt}\).\n This translates to \(P = $1,000,000 / e^{0.1 * 25}\). Carry out this calculation to determine the exact principal needed.

Step-by-step solution

Identify the Given Values

First, identify the given values from the question. These are: \n A = $1,000,000 (the desired amount at retirement)\n r = 10% = 0.1 (the interest rate, written as a decimal) \n t = 25 (the number of years)

Apply the Formula for Continuously Compounded Interest

Next, apply the formula for continuously compounded interest to find the principle: \n \(P = A / e^{rt}\)\n Substitute the given values into this equation: \n \(P = $1,000,000 / e^{0.1 * 25}\)

Calculate the Principal

Calculate \(P = $1,000,000 / e^{0.1 * 25}\)\n This will give the initial amount that needs to be invested in order to have $1,000,000 at retirement after 25 years at an interest rate of 10%.

Key concepts

Retirement Planning

When thinking about retirement planning, time becomes one of the most critical elements. The earlier you start, the better. Let's imagine you're planning to retire with a goal of having $1,000,000 in your account. Knowing how much you need to invest today requires understanding how interest compounds over time. In this exercise, we focus on continuously compounded interest, a method beneficial for long-term savings.

Continuously compounded interest can seem tricky at first, but it simply means your investment is growing at an exponential rate constantly, rather than at set intervals like annually or quarterly. This is important for retirement planning because it could mean that even smaller principal amounts will grow significantly over time.

• Define your retirement needs early
• Understand different compounding methods
• Consider starting with smaller investments

Starting early and choosing the right compounding method can make reaching your retirement goals more attainable. Whether your goal is a leisurely lifestyle or just being comfortable, decide that now and plan accordingly.

Exponential Growth

Exponential growth occurs when a quantity increases at a rate proportional to its current value. In the context of investments, this phenomenon is important. For instance, if you invest your money with continuous compounding, your balance grows exponentially over time.

Consider the formula for continuously compounded interest: \[ P = A / e^{rt} \] Here, \(A\) is the amount you want after time \(t\), \(r\) is the interest rate, and \(e\) represents the base of the natural logarithm, approximately equal to 2.71828. This formula shows how investments can grow more rapidly compared to simple or annually compounded interest. The power of exponential growth means that your investment can potentially double, triple, or more, given enough time and a favorable interest rate.

• Interest compounds continuously
• Balance grows exponentially
• Long-term growth potential is substantial

Understanding how exponential growth works empowers you to make more informed decisions about your savings and investments.

Principal Calculation

Calculating the principal for an investment involves determining how much money you need to invest today to reach a certain monetary goal in the future. Given the formula for continuously compounded interest, you can determine the current principal \(P\) needed to achieve a desired amount \(A\) in the future.

Using our example: \[ P = \frac{1,000,000}{e^{0.1 \times 25}} \] You divide the future desired amount by \(e\) raised to the power of the interest rate times the number of years. This calculation gives you the necessary principal to invest. Understanding LaTeX or how to plug these figures into a calculator is crucial for arriving at accurate numbers.

Calculating the principal might sound complex, but these steps simplify it:

• Identify your future financial goal
• Use the correct interest rate and time period
• Apply the formula for continuously compounded interest

With the right tools, determining the principal ensures you’re on track to achieve your financial goals efficiently.