Question

You are the beneficiary of a life insurance policy. The insurance company informs you that you have two options for receiving the insurance proceeds. You can receive a lump sum of $200,000 today or receive payments of $1,400 a month for 20 years. You can earn 6 percent on your money. Which option should you take and why?

Answer 1

Option 1 = $200,000 today

Option 2 = $1400 a month for 20 years , interest =6%

Converting option 2 into Present value terms = $1400×PVIFA (05%,240 periods)

=$1400×139.58 [1/r(1-1/(1+r)^n]

=$195,413.08

Option 1 > option 2

Option 1 ( present value $200,000) is greater than option 2 (present value $195,413.08).

So option 1. Receiving lumpsum sum of $200,000 is better option.