Question

Longstreet died, leaving an insurance policy to his heir, Stuart. The contract provides that the beneficiary can choose any one of the following four options:

1. A) $550,000 immediate cash

2. B) $40,000 every three months, payable at the end of each quarter for five years

3. C) $180,000 immediate cash and $18,000 every three months for ten years, payable at the beginning of each

   three-month period

4. D) $40,000 every three months for three years and $15,000 each quarter for the following twenty-three

   quarters, all payments payable at the end of each quarter.

Stuart has come to you to ask for assistance and your advice. If money is discounted at a rate of 8% annually, which option would you recommend (in terms of pure value calculation)?

Answer 1

	The option which has the highest PV when discounted at 8% is to be chosen.
OPTION	CALCULATION	PV
A	=550000 =	$ 5,50,000.00
B	=40000*(1.02^20-1)/(0.02*1.02^20) =	$ 6,54,057.33
	[The 40000 is an annuity and the formula for PV of
	annuity is used]
C	=180000+18000*1.02*(1.02^40-1)/(0.02*1.02^40) =	$ 6,82,246.60
	[18000 is an annuity due and the formula for finding
	PV of annuity due is used]
D	=40000*(1.02^12-1)/(0.02*1.02^12)+((15000*(1.02^23-1)/(0.02*1.02^23*1.02^36) =	$ 5,57,522.58
	RECOMMENDATION:
	Option [C] is recommended as it gives the highest PV.