Question

CLIENT 4

Arthur F.’s situation also involved the amount of $40,000. He had received an inheritance of $40,000 from a great-aunt and had been offered an annuity of $5,000 a year for 25 years, or a total of $125,000 at a cost of $40,000. He also had a number of alternatives available, the lowest of which offered a 12 per cent annual compounded return. Arthur F. like the annuity, but was willing to invest in it only if it offered a 12% return or better.

Should the Individual accept the annuity?

Answer 1

Computation of Present Value of both the options:
Option I :
Receiving total $40,000 today
Present Value	=	$40,000 X 1
	=	$40,000
Option II :
Receiving $5,000 for 25 years @ 12% under Annuity
Present Value of Annuity	=	$5,000 [(1 - (1/1.12)^25) / 1.12]
	=	$39,215.70
Therefore, Present Value under Option II is lower than Option I. Hence, Annuity shall not be accepted and It is beneficial to Receive total $40,000 today.