Question

Your mom is thinking of retiring. Her retirement plan will pay her either $ 200,000 immediately on retirement or $ 280,000 five years after the date of her retirement. Which alternative should she choose if the interest rate​ is: a. 0 % per​ year? b. 8 % per​ year? c. 20 % per​ year?

Answer 1

a.Present value of $200,000=$200,000

Present value of $280,000=$280,000*Present value of discounting factor(rate%,time period)

=$280,000

Hence $280,000 must be chosen having higher present value.

b.Present value of $200,000=$200,000

Present value of $280,000=$280,000*Present value of discounting factor(rate%,time period)

=$280,000/1.08^5

=$280,000*0.680583197

=$190,563.30

Hence $200,000 must be chosen having higher present value.

c.Present value of $200,000=$200,000

Present value of $280,000=$280,000*Present value of discounting factor(rate%,time period)

=$280,000/1.2^5

=$280,000*0.401877572

=$112,525.72

Hence $200,000 must be chosen having higher present value.