Question 1 (3 points) Randy had two term policies to compare with costs as shown
ID: 2645866 • Letter: Q
Question
Question 1 (3 points)
Randy had two term policies to compare with costs as shown below. Calculate the NPV at a 6 percent after-tax discount rate. Which one should she select and why?
Year
A
B
1
$225
$300
2
$275
$310
3
$350
$320
4
$400
$330
5
$500
$340
NPV of Policy A =
(Round your answer to the nearest whole dollar. Omit the comma, +/- sign, and "$" sign in your response)
NPV of Policy B =
(Round your answer to the nearest whole dollar. Omit the comma, +/- sign, and "$" sign in your response)
Which one should she select?
(Enter "Policy A" or "Policy B" in the block below)
Question 2 (3 points)
Question 2 options:
1) Given the following information:
Guaranteed Contract Premium
Guaranteed Death Benefit
Projected Dividend
Projected Cash Value
Term Premium
Life_Premium Minus Term_Premium and Dividend
$2,300
$200,000
0
0
$325
???
$2,300
0
0
$330
???
$2,300
0
0
$335
???
$2,300
0
$3,500
$340
???
$2,300
$250
$6,000
$355
???
$2,300
$400
$9,000
$370
???
$2,300
$600
$12,000
$390
???
$2,300
$750
$15,000
$400
???
$2,300
$900
$18,000
$410
???
$2,300
$1,000
$24,000
$430
???
(a) Find the return (Internal Rate of Return) on the whole life insurance policy when the cost of term is included.
(Round your answer to the nearest 2 decimals, i.e. "3.56" " 4.11" or "12.93". Omit the "%" sign in your response)
(b) Which policy would you select if you can invest the difference between the term and whole life policies
Year
A
B
1
$225
$300
2
$275
$310
3
$350
$320
4
$400
$330
5
$500
$340
Explanation / Answer
Answer to Question 1 is provided below:
NPV is the difference between the present value of cash inflows and cash outflows. Cash flows are discounted with the use of a specific discount/required rate of return. The formula for calculating NPV is:
NPV = Cash Flow Year 0 + Cash Flow Year 1/(1+Discount Rate)^1 + Cash Flow Year 2/(1+Discount Rate)^2 + Cash Flow Year 3/(1+Discount Rate)^3 + Cash Flow Year 4/(1+Discount Rate)^4 + Cash Flow Year 5/(1+Discount Rate)^5
_________________
Using the values provided in the question, we get,
NPV (Policy A) = 225/(1+6%) + 275/(1+6%)^2 + 350/(1+6%)^3 + 400/(1+6%)^4 + 500/(1+6%)^5 = $1441.35 or $1441
______________
NPV (Policy B) = 300/(1+6%) + 310/(1+6%)^2 + 320/(1+6%)^3 + 330/(1+6%)^4 + 340/(1+6%)^5 = $1343.05 or $1343
______________
Policy B should be selected as it results in a higher NPV.
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