Question

DeSantis & Daughter offers a defined benefit plan. On the day you retire, you are offered two options. Option one is to take a lump-sum distribution of $855,000 today or receive an annuity of $62,500 per year in equal monthly installments for 25 years. The rate you believe you can earn on these funds is 5.35%. To maximize your value, you:

A) take the 20-year annuity.

B)take the lump sum distribution.

C)can choose either option as they have the same value.

Answer 1

Option 1: Lumpsum distributon of $855,000 today.

We need to calculate the present value of the second option of the 25 year annuity.

Information provided
Monthly installment= $62,500/12= $5,208.33

Time= 25 years*12= 300 months

Interest rate= 5.35%/12= 0.4458% per month

The present value is calculated by entering the below in a financial calculator:

PMT= 5,208.33

N= 300

I/Y= = 0.4458

Press the CPT key and PV to compute the present value,

The value obtained is 860,684.90.

Therefore, the present value of the annuity is $860,684.90.

Hence, to maximize your value, you should take the 25 year annuity.

The answer is option a.

In case of any query, kindly comment on the solution.