Question

You have an investment from which you can receive your return in one of the following ways: Option A: An annuity with payments of $100,000 each for the next ten years, with the first payment commencing today. Option B: A lump-sum one-time payment of $1,005,757 after five years. The interest rate is 6%, compounded annually. Which option has the greater present value?

• Option B.

• Both options have the same present value.

• Option A.

Answer 1

We need to find the present value of both the options.

Option A: Present Value of Annuity using financial calculator

We take the present value of 9 future cash annuities and add 1 annuity received today to find the present value

PV 0f 9 annuities

PMT = 100000

FV = 0

I/Y = 6

N = 9

Compute PV we get, 680,169.23

Hence PV of option A = 680169.23+100000 = 780,169.23

Option B :

FV = 1,005,757

I/Y = 6

N = 5

PMT = 0

Compute PV we get 751,560

Option A has greater present value