Question

18-. You are the beneficiary of a life insurance policy. The insurance company informs you that you have two options for receiving the insurance proceeds. You can receive a lump sum of $200,000 today or receive payments of $1,400 a month for 20 years. You can earn 6 percent on your money. Which option should you take and why?

Answer 1

OPTION 1

LUMP SUM = 200,000

OPTION 2

PMT = 1400

i = 0.5%

n =20

PV OF ANNUITY = PMT x (1-1 /(1+i)ⁿ) / i

=1,400 x (1 - 1/(1+0.5%)²⁰ ) / 0.5%)

=1,400 x (1 - 1/1.04895577) / 0.5%

=1,400 x(1 - 0.905062904 ) / 0.5%

=1,400 x (0.094937096 ) / 0.5%

=1,400 x 18.98741195

=26,582.38681

SO LUMP SUM VALUE MORE THAN ANNUITY TEREFORE LUMP SHOULD BE CHOSEN

BUT I BELIEVE THERE IS AN ERROR IN QUESTION AND PERIODIC PAYMENTS SHOULD BE 14,000

IN THIS CASE VALUE OF ANNUITY BECOMES = 2,65,823.87

THEREFORE ANNUITY SHOULD BE CHOSEN OVER LUMP SUM