2009 Annual Edition/Test Bank
Flora Company owed $100,000 to the National Bank. Flora borrowed the funds to purchase land,
which secures the loan.
p. 5-33 | p. 5-34
Sungho is married, files a joint return, and expects to be in the 35% marginal tax bracket for the
foreseeable future. All of his income is from salary and all of it is used to maintain the household.
He has a paid-up life insurance policy with a cash surrender value of $50,000. He paid $24,000 of
premiums on the policy. If he retains the policy, the insurance company will pay him $2,500
(5%) interest each year. Sungho thinks he can earn a higher return if he cashes in the policy and
invests the proceeds.
What before-tax rate of return would Sungho be required to earn on the proceeds from cash-
ing in the policy to equal the return earned with the insurance company?
Assume Sungho estimates he can earn an 7% before-tax rate of return on the proceeds from
cashing in the policy. Assume he can earn an 7% return for the remainder of his life and that
he will reinvest all earnings at the same 7% before-tax rate of return. If Sungho expects to
live 10 more years, which alternative will yield the greater amount to his beneficiaries upon
Sungho’s death? (Given: The future value of an annuity in 10 years assuming a 4.55% re-
turn is 12.32. The future value of an annuity in 10 years assuming a 3.25% return is 11.60).