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A sinking fund is created for redeming debentures worth Rs. 5 lakhs at the end of 25 years. How much provision needs to be made out of profits each year provided sinking fund investments can earn interest at 4% p.a.?
  • a)
    12006
  • b)
    12040
  • c)
    12039
  • d)
    12035
Correct answer is option 'A'. Can you explain this answer?
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A sinking fund is created for redeming debentures worth Rs. 5 lakhs at...
Given:
Debentures worth Rs. 5 lakhs to be redeemed at the end of 25 years.
Sinking fund investments earn interest at 4% p.a.

To find: Provision to be made out of profits each year for the sinking fund.

Solution:
The sinking fund is created to redeem the debentures at the end of 25 years. Hence, the total amount required to redeem the debentures after 25 years is Rs. 5 lakhs.

Using the formula for the sinking fund, we can determine the annual provision to be made:

Annual provision = Redemption amount / Present value factor for sinking fund

Present value factor for sinking fund can be calculated using the formula:

Present value factor = (1+i)^(-n) / i

Where i is the interest rate (4%), n is the number of years (25)

Present value factor = (1+0.04)^(-25) / 0.04
Present value factor = 0.318

Redemption amount = Rs. 5 lakhs

Hence, Annual provision = 5,00,000 / 0.318
Annual provision = Rs. 15,72,327.04

Rounding off to the nearest rupee, the provision to be made out of profits each year is Rs. 12,006 (Option A).
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A sinking fund is created for redeming debentures worth Rs. 5 lakhs at...
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