Congratulations! You have just won the Magazine Peddlers Sweepstakes! Spokesman

Question

Congratulations! You have just won the Magazine Peddlers Sweepstakes! Spokesman Ferd McMoney has indicated that you have the choice of receiving $25,000 a year for the next 15 years with the first payment to be provided in one year or alternatively, $220,000 in cash. If you believe that your opportunity cost or return is 8%, based on the concept of time value, which should you choose? There is not enough information provided to answer the question based on time value of money concepts The S220,000cash payment The values are equivalent and either is acceptable based on the information The S25,000 per year for 15 years

Explanation / Answer

Answer: The $220,000 cash payment

Present value of annuity payment for next 15 years =

Annuity [{(1+r)n -1} / {(1+r)n * r}] where r = Rate of Oppportunity cost, n = no. of years

= $25,000 [{(1+0.08)15 - 1} / {(1+0.08)15 * 0.08} = $25,000 (2.17217/0.25377) = $213,986.96

The present value of the $25,000 payment, 15 years is lower than $220,000 payment now. So he should accept the $220,000 now.

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