Question

when you retire you are offered a pension of 2,000 per month for 20 years or a lump sum payment. At an interest rate of 5%, what should the value of the lump sum be?

Answer 1

Offer:

Pension per month = $2,000 for 20 years.

Interest rate = 5%p.a

• Monthly pension = $2,000
• For number of months = 20 * 12 = 240 months at rate of 5%p.a
• So monthly rate = 5% / 12 = 0.42% = 0.0042

Assuming pension is paid at the end of every month, Present value of these cash flows:

Lump sum amount = $2,000 / (1+0.0042)^1 + $2,000 / (1+0.0042)^2 + $2,000 / (1+0.0042)^3 + .... + $2,000 / (1+0.0042)^239 + $2,000 / (1+0.0042)^240

Lump sum amount = $303,050.63