Question

Julie has just retired. Her company’s retirement program has two options as to how retirement benefits can be received. Under the first option, Julie would receive a lump sum of $157,000 immediately as her full retirement benefit. Under the second option, she would receive $20,000 each year for 6 years plus a lump-sum payment of $65,000 at the end of the 6-year period. Click here to view Exhibit 7B-1 and Exhibit 7B-2, to determine the appropriate discount factor(s) using tables.

Required:

1-a. Calculate the present value for the following assuming that the money can be invested at 12%.

1-b. If she can invest money at 12%, which option would you recommend that she accept?

Answer 1

1a
Present value of First option
	Cash flow	Discount factor	Present value
Lump sum payment	157000	1	157000
Present value of Second option
	Cash flow	Discount factor	Present value
Annual annuity	20000	4.111	82220
Lump sum payment	65000	0.507	32955
Total present value			115175
1b
First option should be accepted

Workings:
Discount factor
Annual annuity	4.111	=(1-(1.12)^-6)/0.12
Lump sum payment	0.507	=1/1.12^6