Question

You are to receive a sum of money, but you can choose one of two scenarios. You can either receive $40,000 today, or receive $56,000 after 10 years at an interest rate of 13% per year compounded annually. Which of the two scenarios would you choose and why?

Answer 1

Option 1 - Receive $40,000 today (at present time, t=0)

Option 2 - Receive $56,000 after 10 year at an interest rate of 13%.

Which option would you choose?
If we consider time zero as the common point of time, then the

Present Value of Option 1 is $40,000

Present Value of Option 2 is

PV = F (1 + i) ^ -N

PV = $56,000 ( 1 + 0.13) ^ -10 = 16,496.95 or 16,497 (rounding off)

From the above it can be seen that choosing Option 1 is better as you are getting more money. In the present value analysis we need to select that option at which the present value is maximum. Hence, receiving 40,000 now is better than receiving 56,000 after 10 years.