Qunitana Pena expects to receive a $500,000 cash benefit when she retires five y
ID: 2443853 • Letter: Q
Question
Qunitana Pena expects to receive a $500,000 cash benefit when she retires five years from today. Ms. Pena's employer has offered an early retirement incentive by agreeing to pay her $300,000 today if she agrees to retire immediately. Ms. Pena desires to earn a rate of return of 12 percent.Required
a. Assuming that the retirement benefit is the only consideration in making the retirement decision, should Ms. Pena accept her employer's offer?
b. Identify the factors that cause the present value of the retirement benefit to be less than $500,000.
Explanation / Answer
a. We have Future Value FV as $500,000, Present Value PV = $300,000 & Cost of Capital Kd=12% & time period n = 5 yrs We know PV = FV/(1+kd)^n So we find PV of $500,000 to help us in decision making PV = 500,000/(1+12%)^5 = $283,713.42 So if Employer is paying her $300,000, She should accept that offer. b. Factor that cause PV of retirement benefit to be less than 500,000 is the discount rate spread over 5 years. The present value and future value of money, and the related concepts of the present value and future value of an annuity, allow an individual or business to quantify and minimize its opportunity costs in the use of money. Opportunity cost, in terms of the use of money, is the benefit forfeited by using the money in a particular way. For instance, if I spend $100 instead of depositing it in a bank that pays 5% interest, I forego the interest that I would have earned in the savings account by spending it instead of saving it, and if I would have saved it, then I forfeit the benefit of what I purchased. Of course, it might be possible to buy some stock, instead, that may double or triple, incurring an even greater opportunity cost. However, the future value of a stock is unpredictable, and the true opportunity cost of anything is really not knowable. However, the opportunity cost can be compared among specific investments where the rate of return is dependent on an interest rate that is either known or can be reasonable estimated by using the formulas for the present value and future value of money. Or a reasonable interest rate can be assumed simply to compare different investments.
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