Arthur is to receive an inheritance of $40,000 from a great-aunt. She is offerin

Question

Arthur is to receive an inheritance of $40,000 from a great-aunt. She is offering him the choice of taking $40,000 today OR an annuity of $5,000 a year for 25 years. He also had a number of investment alternatives available, the lowest of which offered a 12% annual compounded return. Arthur liked the annuity, but was willing to invest in it only if it offered a 12% return or better. Required: 1. In a narrative format in Word, please address the following with Arthur:

a. Utilizing time value of money calculations as in the previous problems, please determine what Arthur should do. That is, should he take the $40.000 today or should he take the $5,000 a year for 25 years?

Explanation / Answer

Here, we need to calculate the PV of both options,

Receiving 40,000 today will have a PV = $40,000

The PV of an annuity that is received for 25 years at the rate of 5,000 per year with an interest of 12% is given as below:

PV of an annuity = A[{1-(1/1+r)^n}/r] where A = 5,000. r = 12% = 0.12 and n= 25

PV = 5000[{1-(1/1+0.12)^25}/0l.12] = $39,215.70

Since the PV of the annuity is lower, Arthur is better off receiving the entire 40,000 today

Related Questions

Navigate

• Browse (All)
• Browse A
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.