Question

Ana has won a lottery. She was offered two options to receive the award: She can either take it in five installments of $60,000 annually, starting from now; or she can take a lump-sum of $255,000 now. Assuming (a) interest at an annual rate of 5% compounded annually, or (b) interest at an annual rate of 6% compounded continuously, which option should she choose under the consideration of cash value only?
A) If the interest is at the annual rate of 5%, compounded annually, then the present value of the five installments is $______. B) If the interest is at the annual rate of 6%, compounded continuously, then the present value of the five installments is $______.

Answer 1

Answer:

Results are below.

Step-by-step explanation:

Giving the following information:

She can either take it in five installments of $60,000 annually, starting from now; or she can take a lump-sum of $255,000 now.

First, we determine the value of the 5 installments using a 5% annual compounded rate.

We calculate the future value, and then the present value:

FV= {A*[(1+i)^n-1]}/i

A= annual payments

FV= {60,000*[(1.05^5) - 1]} / 0.05

FV= $331.537.88

PV= FV/(1+i)^n

PV= $259,768.60

At an annual rate of 5% compounded annually, she should choose the five installments instead of the $255,000.

Now, if the annual rate is 6% continuously compounded.

First, we need to calculate the effective interest rate:

r= e^i - 1

r= effective inerest rate

r= e^0.06 - 1

r= 0.0618

FV= {60,000*[(1.0618^5) - 1]} / 0.0618

FV= 339,443.23

PV= 339,443.23/1.0618^5

PV= $251,509.01

At an annual rate of 6% compounded continuously, she should choose the $255,000.