Question

Julia Baker died, leaving to her husband Henry an insurance policy contract that provides that the beneficiary (Henry) can choose any one of the following four options. Money is worth 2.50% per quarter, compounded quarterly. Compute Present value if: Click here to view factor tables Correct answer. Your answer is correct. (a) $55,260 immediate cash. (Round factor values to 5 decimal places, e.g. 1.25124 and final answer to 0 decimal places, e.g. 458,581.) Present value $Entry field with correct answer 55260 SHOW SOLUTION LINK TO TEXT LINK TO TEXT Correct answer. Your answer is correct. (b) $4,040 every 3 months payable at the end of each quarter for 5 years. (Round factor values to 5 decimal places, e.g. 1.25124 and final answer to 0 decimal places, e.g. 458,581.) Present value $Entry field with correct answer 62980 SHOW SOLUTION LINK TO TEXT LINK TO TEXT Correct answer. Your answer is correct. (c) $19,160 immediate cash and $1,916 every 3 months for 10 years, payable at the beginning of each 3-month period. (Round factor values to 5 decimal places, e.g. 1.25124 and final answer to 0 decimal places, e.g. 458,581.) Present value $Entry field with correct answer 68459 SHOW SOLUTION LINK TO TEXT LINK TO TEXT Incorrect answer. Your answer is incorrect. Try again. (d) $4,040 every 3 months for 3 years and $1,490 each quarter for the following 25 quarters, all payments payable at the end of each quarter. (Round factor values to 5 decimal places, e.g. 1.25124 and final answer to 0 decimal places, e.g. 458,581.) Present value $Entry field with incorrect answer 68894 LINK TO TEXT LINK TO TEXT Incorrect answer. Your answer is incorrect. Try again. Which option would you recommend that Henry exercise?

Answer 1

Quarterly interest rate = 2.50%

Option A:

$55,260 immediate cash:

Present value = $55,260

Option B:

$4,040 every 3 months payable at the end of each quarter for 5 years:

Period = 5 years or 20 quarters

Present value = $4,040 * PVA of $1 (2.50%, 20)
Present value = $4,040 * 15.58916
Present value = $62,980

Option C:

$19,160 immediate cash and $1,916 every 3 months for 10 years, payable at the beginning of each 3-month period:

Period = 10 years or 40 quarters

Present value = $19,160 + $1,916 * PVAD of $1 (2.50%, 40)
Present value = $19,160 + $1,916 * 25.73034
Present value = $68,459

Option D:

$4,040 every 3 months for 3 years and $1,490 each quarter for the following 25 quarters, all payments payable at the end of each quarter:

Present value = $4,040 * PVA of $1 (2.50%, 12) + $1,490 * PVA of $1 (2.50%, 25) * PV of $1 (2.50%, 12)
Present value = $4,040 * 10.25776 + $1,490 * 18.42438 * 0.74356
Present value = $61,854

Present value of Option C is highest. So, Julia should select Option C.