Question

You are the beneficiary of a life insurance policy. The insurance company offers two options for receiving the proceeds: a lump sum of $50,000 today or payments of $550 a month for ten years. If you can earn 6%, compounded monthly, which option should you take and why?

a. Accept the lump sum because the payments are only worth $49,540.40 today.

b. Accept the monthly payments because they are worth $51,523.74 today.

c. Accept the payments because they are worth $53,737.08 today.

d. Accept the $50,000 because the payments are worth only $49,757.69 today.

e. Accept neither because the US dollar is worthless.

Answer 1

Effective monthly rate = 6%/12 = 0.5%

The present value of the annuity is:

PV of annuity < lump sum

So, accept a lump sum of $50,000 because the payments are worth only $49,540.40 today. (Option a)