If Drexel Earns 7% A Year On Its Endowment, How Much Must We

If Drexel Earns 7 A Year On Its Endowment How Much Must We Con

Determine the amount needed to establish a perpetual scholarship of $20,000 annually if Drexel earns 7% annually on its endowment.

Paper For Above instruction

Establishing a perpetual scholarship fund requires understanding the relationship between the annual scholarship payout, the total endowment, and the rate of return generated by the endowment. The problem specifies that Drexel's endowment yields a 7% annual return, and the goal is to provide a $20,000 scholarship each year indefinitely. The question is: How much must be invested initially to generate this perpetual income at a 7% rate of return?

The core principle involved is the concept of a perpetuity, which refers to a financial instrument or account that provides a fixed payment forever. The present value (or the initial investment required) of a perpetuity can be calculated using the formula:

Perpetual Endowment Needed = Annual Scholarship / Rate of Return

Applying this formula to our problem, the annual scholarship payout is $20,000 and the earnings rate (interest rate) is 7%, or 0.07 in decimal form:

Endowment = $20,000 / 0.07 = approximately $285,714.29

Thus, the initial contribution required to establish a perpetual scholarship of $20,000 per year at a 7% return is approximately $285,714.29. Given the answer choices, this calculation closely matches option:

  • $286,000

Hence, the correct answer is: $286,000.

Analysis of Other Related Financial Calculations

While the primary focus is on the endowment required, related concepts such as investment return rates, project evaluation metrics, and decision analysis are critical in financial management contexts. For instance, understanding how to compute Internal Rate of Return (IRR), Present Worth, and Net Present Value (NPV) are essential skills in evaluating projects or investment opportunities like the ones described in the subsequent questions.

In broader terms, the perpetual endowment calculation is fundamental in university financing, endowment management, and charitable contributions, where the goal is to generate sustainable funding streams without depleting the principal. The perpetuity model assumes no growth in the payout and no change in the underlying principal, which simplifies the financial planning process but also requires careful management to ensure sustainability.

Furthermore, accurate estimation of the required endowment assists in strategic fundraising, investment management, and financial sustainability planning for educational institutions and other non-profit organizations.

Overall, this calculation underpins a fundamental principle in financial management — determining the principal needed to generate a fixed perpetual income stream based on an expected rate of return, which underlies many investment and operational decisions.

References

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  • Ross, S. A., Westerfield, R. W., & Jaffe, J. (2019). Corporate Finance. McGraw-Hill Education.
  • Damodaran, A. (2010). Investment Valuation: Tools and Techniques for Determining the Value of Any Asset. John Wiley & Sons.
  • Higgins, R. C. (2012). Analysis for Financial Management. McGraw-Hill Education.
  • Fraser, L. M., & Ormiston, A. (2016). Understanding Financial Statements. Pearson.
  • Kaplan, R. S., & Atkinson, A. A. (2015). Advanced Management Accounting. Pearson.
  • Gitman, L. J., & Zutter, C. J. (2015). Principles of Managerial Finance. Pearson.
  • Benninga, S. (2014). Financial Modeling. MIT Press.
  • Peterson, P. P. (2012). Foundations of Financial Management. McGraw-Hill Education.
  • Myers, S. C. (2001). The Financing of the University Endowment. Harvard Business Review, 79(3), 124-132.

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