Question

ÂSuppose you have a choice between receiving a lump-sum payment of $10,000 today or four annual payments of $2,750 (with the first payment today).

Of the following, which is the highest annual interest rate at which you would prefer the four annual payments over the lump-sum payment?

a. 2%b. 5%c. â7%d. 10%

Answer 1

a. 2

Step-by-step explanation:

That interest rate will be preferred where present value of $2,750 for four years is highest .

To calculate present value for four years , we will use uniform payment table for present value at 2%,5%,7% and 10% rate.

Present value factor

at 2%- 3.8077 value - 2750* 3.8077 = 10471.2

At 5% - 3.5460 value - 2750* 3.5460 = 9751.5

With increase in interest rates , amount will be reduced .

Therefore 2% will be the highest rate acceptable.

Answer 2

a. 2%

Step-by-step explanation:

That interest rate will be preferred where present value of $2,750 for four years is highest .

To calculate present value for four years , we will use uniform payment table for present value at 2%,5%,7% and 10% rate.

Present value factor

at 2%- 3.8077 value - 2750* 3.8077 = 10471.2

At 5% - 3.5460 value - 2750* 3.5460 = 9751.5

With increase in interest rates , amount will be reduced .

Therefore 2% will be the highest rate acceptable.