a 65 year old man is retiring and can take either 500,000 in cash or an ordinary

Question

a 65 year old man is retiring and can take either 500,000 in cash or an ordinary annuity that promises to pay him 50000 per year as long as he lives. which of the following statements is most correct?

a.because of the time value of money, the man will always be better off taking the $500,000 up front

b. The higher the interest rate the more likely the man will prefer the $500,000 lump sum

c. if the man expects to live more than 10 years, then he will prefer the annuity

d. If the man is certain the company will not default on its future payments, he should select $50,000 per year

Explanation / Answer

Answer: The most correct statement is:

" b. The higher the interest rate the more likely the man will prefer the $500,000 lump sum "

=> Higher the interest discount rate, lower will the present value of annuity, like annuity of $50000 for 15 years at 5% and 15% are $519000 & $292350 respectively. So, at 5% interest discount rate annuity is acceptable and at 15% interest discount rate $500000 in cash is acceptable.

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