Question

1-You have won $1,000,000 playing McDonald’s monopoly. To receive your prize you have two choices. First, you may receive $50,000 at the end of each year for the next 20 years. Second, you may receive a lump sum payment of $750,000. Assuming the lump sum payment reflects fair market value, what does this imply about current interest rates?

Select one:

a. Current interest rates are 6.514%

b. Current interest rates are 7.976%

c. Current interest rates are 7.441%

d. Current interest rates are 5.465%

e. None of the above

2-You plan to deposit $900 per year in the bank at the end of each of the next 7 years. You then plan to leave the money in the bank for another 8 years. If the interest rate is 4% per year, how much will you have in the bank at the end of year 15?

Select one:

a. $9,728

b. $7108

c. $12,801

d. $9354

e. None of the above.

Answer 1

1. Since both the amounts are equivalent, the present value of these annuity payments is $750,000. This implies:

750000 = 50000/(1+r) + 50000/(1+r)^2 + 50000/(1+r)^3 + ........... + 50000/(1+r)^20

Hence, r = 2.911%. E. None of the above.

2. For this we need to calculate the future value. After 7 years, the future value will be:

FV = 900 x 1.04^6 + 900 x 1.04^5 + ..... + 900 = 7108.465.

Now, we need to calculate the value after the next 8 years.

FV = 7108.465 x 1.04^8 = 9728.425 (Option A)