Question

You have a chance to buy an annuity that pays $1,000 at the end of each year for 5 years. You could earn 6% on your money in other investments with equal risk. What is the most you should pay for the annuity?

Answer 1

Explanation:

To determine the most you should pay for the annuity, you can use the present value formula for an annuity.

PV = C * [(1 - (1 + r)^(-n)) / r]

where PV is the present value, C is the annual cash flow, r is the interest rate, and n is the number of periods.

In this case, C is $1,000, r is 6%, and n is 5 years. Plugging these values into the formula, we get:

PV = $1,000 * [(1 - (1 + 0.06)^(-5)) / 0.06]

PV = $4,212.10

Therefore, the most you should pay for the annuity is $4,212.10. If you pay more than this amount, you would be better off investing your money elsewhere at a 6% interest rate.