Question

You are thinking of retiring. Your retirement plan will pay you either $250,000 immediately on retirement or $350,000 five years after the date of your retirement. Which alternative should you choose if the interest rate is: a. 0% per year b. 8% per year c. 20% per year

Answer 1

To determine the best retirement plan option, calculate the present value of each alternative at different interest rates. At 0% interest, both alternatives have the same present value. At 8% interest, choose the $350,000 received after 5 years, and at 20% interest, also choose the $350,000 received after 5 years.

Step-by-step explanation:

To determine which alternative to choose for retirement, we need to calculate the present value of each option at different interest rates. The present value is the current worth of a future cash flow.

If the interest rate is 0% per year, both alternatives have the same present value. At an interest rate of 8% per year, the present value of $250,000 is $154,338.41, while the present value of $350,000 received after 5 years is $223,763.66. Lastly, at an interest rate of 20% per year, the present value of $250,000 is $64,516.13, while the present value of $350,000 received after 5 years is $183,467.36.

Based on these calculations, the alternative to choose will depend on the interest rate:

If the interest rate is 0% per year, it doesn't matter which alternative you choose, as they have the same present value.

If the interest rate is 8% per year, it is better to choose the $350,000 received after 5 years, as it has a higher present value.

If the interest rate is 20% per year, it is better to choose the $350,000 received after 5 years, as it has a higher present value.

Answer 2

To determine which retirement option to choose, compare the present values of the two alternatives. At different interest rates, the decision may vary.

Step-by-step explanation:

To determine which alternative to choose, we need to compare the present value of each option. The present value is the current worth of a future sum of money, taking into account the time value of money.

a. At a 0% interest rate, the present value of $250,000 immediately is $250,000 and the present value of $350,000 after 5 years is also $350,000. So, it doesn't matter which alternative you choose.

b. At an 8% interest rate, the present value of $250,000 immediately is $183,824.56 and the present value of $350,000 after 5 years is $230,023.54. You should choose the option with the higher present value, which is $350,000 after 5 years.

c. At a 20% interest rate, the present value of $250,000 immediately is $96,524.63 and the present value of $350,000 after 5 years is $138,768.12. You should choose the option with the higher present value, which is $350,000 after 5 years.