Question

In: Finance

An insurance policy offers you the option of being paid $750 per month for 20 years...

An insurance policy offers you the option of being paid $750 per month for 20 years or a lump sum of $50,000. Which has the greater value if the current rate of return is 4.5% compounded monthly and you expect to live for at least 20 years?

(Please work out thoroughly, need to understand the work process)

Solutions

Expert Solution

Option 1:

Monthly Payment = $750
Time Period = 20 years or 240 months

Annual Interest Rate = 4.50% compounded monthly
Monthly Interest Rate = 4.50% / 12
Monthly Interest Rate = 0.375%

Present Value = $750/1.00375 + $750/1.00375^2 + … + $750/1.00375^239 + $750/1.00375^240
Present Value = $750 * (1 - (1/1.00375)^240) / 0.00375
Present Value = $750 * 158.065437
Present Value = $118,549.08

Option 2:

Lump Sum = $50,000

Present Value = $50,000

Option 1 has greater value then Option 2.

jeff jeffy answered 2 years ago
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