Question

You are offered the choice between the following options:

a) Get $3,200 each year for 10 years. First payment after the first year.

b) Get $7,000 today, and thereafter $3,000 each year for 5 years. First payment after the first year.

c) Get $4,000 each year for 10 years. First payment after 5 years.

The annual interest rate is 8%. Calculate the present values of those three options. Which one would you choose?

Answer 1

  

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a)

Present Value of Annuity =  

where r is the rate of Return for compounding period = 8%

n is the no of compounding period 10 years

=

= 21472.26

b)

Present Value of Annuity =  

where r is the rate of Return for compounding period = 8%

n is the no of compounding period 5 years

=

= 14978.13

c)

Present Value of Annuity after 4 years =  

where r is the rate of Return for compounding period = 8%

n is the no of compounding period 10 years

=

= 26840.3255974

Value today = 26840.3255974 / (1+0.08)^4

= 19728.44

Option a is better.