You are considering two insurance settlement offers. The first offer includes an
ID: 2781542 • Letter: Y
Question
You are considering two insurance settlement offers. The first offer includes annual payments of $50,000 a year for 5 years with the first payment made today. The other offer is the payment of one lump sum amount today. You are trying to decide which offer to accept given the fact that your discount rate is 12%. What is the minimum amount that you will accept today if you are to select the lump sum offer?
$195,618.19
$180,238.81
$197,548.53
$201,867.47
$214,142.50
a.$195,618.19
b.$180,238.81
c.$197,548.53
d.$201,867.47
e.$214,142.50
Explanation / Answer
We have to find the present value of annuity payments expected to be received from the first offer as that amount will be the minimum lumpsum amount required today so that we indifferent between the two offers
Since the first payment is expected to be receive today and annuity if for 5 years and discount rate is 12%, we will used present value of annuity due formula:
Present Value = P + P [(1 - (1+r)-(n-1)) / r]
= 50,000 + 50,000 [(1 - (1+0.12)-(5-1)) / 0.12]
= 50,000 + 50,000 [(1 - 0.6355) / 0.12]
= 50,000 + 50,000 (0.3645 / 0.12)
= 50,000 + 50,000 x 3.037
= 201,867.47
Minimum amount that can be accepted today is $201,867.47
Hence answer d is correct
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