Question

Howie just won a law suit and has been given the choice of two payout options

Option 1: He can receive \$25,000 every six months for twenty years.

Option 2: He can wait and receive 527, 000 every six months for twenty years with the first payment coming one and a half years from now. The appropriate discount rate is 9 percent compounded semiannually

Which option should be chosen ?

Why should that particular option be chosen?

Answer 1

OPtion 1

Particulars	Amount
Cash Flow	$    25,000.00
Int Rate	4.500%
Periods	40

PV of Annuity = Cash Flow * [ 1 - [(1+r)^-n]] /r
= $ 25000 * [ 1 - [(1+0.045)^-40]] /0.045
= $ 25000 * [ 1 - [(1.045)^-40]] /0.045
= $ 25000 * [ 1 - [0.1719]] /0.045
= $ 25000 * [0.8281]] /0.045
$             4,60,039.61

OPtion 2

Particulars	Amount
Cash Flow	$    27,000.00
Int Rate	4.500%
Periods	40

PV of Annuity = Cash Flow * [ 1 - [(1+r)^-n]] /r
= $ 27000 * [ 1 - [(1+0.045)^-40]] /0.045
= $ 27000 * [ 1 - [(1.045)^-40]] /0.045
= $ 27000 * [ 1 - [0.1719]] /0.045
= $ 27000 * [0.8281]] /0.045
$             4,96,842.78

Value after one year = $ 496842.78

Value Today = Value after one year * PVF(r%, n)

= $ 496842.78 * PVF(4.5%, 2)

= $ 496842.78* 0.9157

= $ 454973.8

OPtion 1 has to be selected as the present value is more in that