Fundamentals of Financial Manageme...
Solutions
Fundamentals of Financial Manageme...
EVALUATING LUMP SUMS AND ANNUITIES Kristina just won the lottery, and she must choose among three award options. She can elect to receive a lump sum today of $62 million, to receive 10 end-of-year payments of $95 million, or to receive 30 end-of-year payments of $5.6 million.
- a. If she thinks she can earn 7% annually, which should she choose?
- b. If she expects to earn 8% annually, which is the best choice?
- c. If she expects to earn 9% annually, which option would you recommend?
- d. Explain how interest rates influence her choice.
a.
To determine: The best option if Person K can earn 7% annually.
Lump Sum:
The lump sum is a large amount of money paid on a single occasion instead of paying small amounts from time to time. The amount has been paid for the value of an asset or for other purposes of retirement.
Receive lump sum amount of $62 million.
In this case, present value of amount received is $62 million.
Receive ten year-end payments of $9.5 million.
Given,
Interest rate is 7%.
Tenure is 10 years.
Annual payment received is $9.5 million.
To compute present value of $9.5 million, apply PV formula on spreadsheet.
Table (1)
In this case, present value of amount received is $66...
b.
To determine: The best option if Person K can earn 8% annually.
Lump Sum:
The lump sum is a large amount of money paid on a single occasion instead of paying small amounts from time to time. The amount has been paid for the value of an asset or for other purposes of retirement.
c.
To determine: The best option if Person K can earn 9% annually.
Lump Sum:
The lump sum is a large amount of money paid on a single occasion instead of paying small amounts from time to time. The amount has been paid for the value of an asset or for other purposes of retirement.
d.
To explain: Reason for interest rate affecting choices.
Lump Sum:
The lump sum is a large amount of money paid on a single occasion instead of paying small amounts from time to time. The amount has been paid for the value of an asset or for other purposes of retirement.
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