Question

Julie has just retired. Her company's retirement program has two options as to how retirement benefits can be received. Under the first option, Julie would receive a lump sum of $150,000 immediately as her full retirement benefit. Under the second option, she would receive $14,000 each year for 20 years plus a lump-sum payment of $60,000 at the end of the 20-year period. Page 553 Required: If she can invest money at 12%, which option would you recommend that she accept? Use present value analysis.

Answer 1

Answer:

First option will be recommended.

Explanation:

To determine which option to be taken, we calculate the net present value each option generates. The option generating higher NPV should be recommended.

- Net present value of first option = Lump sum receipt = $150,000.

- Net present value of second option will be found by discounting cash flows at investing rate 12% and calculated as followed:

 +  Present value of 20 equal annual payment of $14,000 + Present value of $60,000 paid in 20 years = (14,000/12%) x [ 1 - 1.12^(-20)] + 60,000/1.12^20 = $110,792.

As net present value of the first option is higher than the second option, first option will be recommended.