Question

If you can earn 10% on your savings account, which of the following investments is worth...

If you can earn 10% on your savings account, which of the following investments is worth more to you?
(1) $5,000 in 3 years;
(2) A 5-year ordinary annuity offering $900 payments
Please explain

Homework Answers

Answer #1

1) $ 5000 in 3 Years

Computation of the Present value

Year Cash flow Disc @ 10% Discounted Cash flows
0 $0.00 1 $0.00
1 $0.00 0.909091 $0.00
2 $0.00 0.826446 $0.00
3 $5,000.00 0.751315 $3,756.57

So the Present Value of $ 5000 received after 3 years is $ 3756.57

2)5 Year Annuity offering $ 900 payments( Assuming annuity received at the end of the year)

Computation of the Present value

Year Cash flow Disc @ 10% Discounted Cash flows
1 $900 0.909091 $818.18
2 $900 0.826446 $743.80
3 $900 0.751315 $676.18
4 $900 0.683013 $614.71
5 $900 0.620921 $558.83
Total $3,411.71

The Present value of the Annuity received at the end of the year is $ 3411.71

Assuming annuity is received at the begining of the year then present value is

Year Cash flow Disc @ 10% Discounted Cash flows
1 $900 1 $900.00
2 $900 0.909091 $818.18
3 $900 0.826446 $743.80
4 $900 0.751315 $676.18
5 $900 0.683013 $614.71
Total $3,752.88

Present value of annuity received at begining of the year is $ 3752.88

Decision making: The present value of $ 5000 to be received after 3 years is greather than Annuity.So it is better to receive $ 5000 after 3 years than Annuity

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