Question

You inherit $527,000. You can receive the $527,000 in one lump sum payment today or, alternatively, receive two amounts: $327,000 in 7 months and $220,000 in 21 months from today. If you can earn 5.5% per annum compounding monthly on your monies, what is the value of the option to receive two payments

Answer 1

Answer: $518,371

To consider the Present value of option we have to find Present value for both cash inflow.

PV = FV / (1+r)n

Where FV = Future value, R = rate of Interest, n = number of periods.

Here We have interest compounding on a monthly basis. So, monthly interest rate = 5.5/12 = 0.4583333%

PV of $327,000 receivable after 7 months from today.

= 327000/ (1+0.004583)7

= $316,698

PV of $327,000 receivable after 7 months from today.

= 220000/ (1+0.004583)21

= $201,673

So, the total value of the alternative option is

$316,698 + $201,673 = $518,371