Question

7. Suppose you have a choice between receiving $2,550,000 today or a 20-year annuity of $250,000, with the first payment coming one year from today. What rate of return is built into the annuity?

Answer 1

We are given,

PV = $2,550,000

Time(t) = 20 years

pmt = $250,000

Interest rate(r) =?

PV = pmt1/(1+r)^1 + pmt2/(1+r)^2 + pmt3/(1+r)^3 + ................ pmt20/(1+r)^20

We can also calculate the interest rate(r) by using a financial calculator by providing the above values,

Interest rate(r) = 7.492895% or 7.49%

Hence annuity has a 7.49% interest rate compounded annually.

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