Question

# You inherit \$545,000. You can receive the \$545,000 in one lump sum payment today or, alternatively,...

You inherit \$545,000. You can receive the \$545,000 in one lump sum payment today or, alternatively, receive two amounts: \$345,000 in 10 months and \$220,000 in 21 months from today. If you can earn 11.6% per annum compounding monthly on your monies, what is the value of the option to receive two payments (in present day value)?

The concept used in the solution is time value of money along with understanding of compound rates.

Calculation

Option 1

Value = \$ 545000 [ Since money is receiving today. Hence it already at present value]

Option 2

Value = 345000 * PVIF(11.60/12, 10) + 220000 * PVIF(11.60/12, 21)

[Explanation : PVIF(r, n) = Present value interest factor at peroidic rate "r" for "n" periods. ]

= 345000 * 0.9083 + 220000 * 0.8171

= \$ 493126

Since option I is greater than option 2, option 1 should be selected.

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