Question

If you were offered to choose between receiving a certain amount of money now, or receiving five equal annual payments, what information will you need to make your decision and how will you decide which option to choose (based only on the principles of economic equivalency)

Answer 1

The information needed to make your decision are:

• Amount to be received now (P)
• Equal Annual payment amount (A)
• Annual interest rate (i)
• Number of annual payment (n). It is already given in the question, i.e., 5

For comparison you have to calculate the present worth of the five annual equal payment (A) using the interest rate using the formula: PW = A(A/P, i, n).

Then compare the PW of five annual payments with the amount to be received now. If the amount to be received now is greater than the PW of five annual payments, then choose first option,i.e. amount receive now.

If the amount to be received now is less than the PW of five annual payments, then choose second option,i.e. five equal annual payments.