Discussion Question Your goal is to have $1,000,000 in 20 years in an investment

Question

Discussion Question Your goal is to have $1,000,000 in 20 years in an investment account that is available for you to withdraw starting 21st year. To that end, you are evaluating multiple options. Which option would you prefer and why? For this problem, assume that you have required cash on hand to be invested. Option #1: Put aside lump sum today, at 8% interest compounded annually. Option #2: Invest specific amount over time (over next 18 years) at 10% compounded annually Option #3: Put aside a lump sum today, at 8% interest compounded annually for 10 years, at which point the account balance in the 10th year reinvests in another account over next 10 years (specific amount for this account is withdrawn and reinvested in another account every year) at 10% interest compounded annually. The first account stops earning interest at the end of 10th year. Hint: All cash flows must be brought at same point for a true comparison. Also remember, a dollar today is worth more than dollar tomorrow.

Explanation / Answer

Option #1

we need to invest (1000000/1.08^20=$214548 today

Optioon #2

We need to put aside (1000000/1.1^18)=$179,858 today

Option #3

We need to put aside (1000000/1.1^10)=385543 this amount to be discounted back with 8% for other 10 years to find PV=385,543/1.08^10=$178,581 today

Therefore Option#3 to be chosen as e need to put aside less cash today i.e. $178,581

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