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 $50,000 today or receive payments of $641 a month for ten years. You can earn 6.5% on your money. Which option should you take and why?

a. You should accept the payments because they are worth $56,451.91 today.
b. You should accept the payments because they are worth $56,523.74 today.
c. You should accept the payments because they are worth $56,737.08 today.
d. You should accept the $50,000 because the payments are only worth $47,757.69 today.E. You should accept the $50,000 because the payments are only worth $47,808.17 today.

Answer 1

You need to have in mind that you are looking at the present value because the lump sum is worth $50,000 today. You need to compare the present for 10 years of your life would be worth today.

So:

FV=0

N=10 X 12=120

PMT= 641

I=6.5% / 12= 0.5417%

Solve for PV= $56,451.91 (is larger than $50,000)