Question

6. Ms. Jones is a 74 year old retired union worker currently receiving a pension that pays $6,000 per year annuity for remainder of her life. She is offered a buy-out where she would receive a cash payment of $33,500 today in lieu of the annual pension payments. Ms. Jones estimates her life expectancy to be 85 and that she can earn a 9% return on her investment. Should Ms. Jones take the buyout or continue to receive the pension payments?

Answer 1

Present value of pension payment is computed as follows:

Present value = Annual amount x [ (1 – 1 / (1 + r)ⁿ) / r ]

= $ 6,000 x [ (1 - 1 / (1 + 0.09)¹¹ ) / 0.09 ]

= $ 6,000 x 6.805190552

= $ 40,831.14 Approximately

Present value of receiving buy out will be $ 33,500 since the same is received today only.

So, the Ms. Jones shall continue to receive the pension payment, since the present value of pension payment is greater than the present value of buyout

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