Friday
August 29, 2014

Homework Help: Finance

Posted by Antoinette on Sunday, March 18, 2007 at 2:09am.

Your Uncle has two alternative inheritence for you.
A. You receive 5000 today and 1000 per year for the next 8 years.
or
B. 5000 today and nothing each year for the next 7 years and at end of 8th year receive 12,000

Which is best and why.

Current interest rate is 10% annually on both scenerios.

Compare what you would have at the end of eight years if you invested the payments and got 10% interest. That means comparing
A. 5000*(1.1)^8 + 1000*(1.1)^7 + 1000*(1.1)^6 + 1000*(1.1)^5 + .. 1000*(1.1)+ 1000.
and
B. 5000*(1.1)^8 + 12,000.
Both options get 8 years of compounded interest on $5000, so let's just compare the rest.
Option A gets an additional 1948.72 + 1771.56 + 1610.51 + 1464.10 + 1331.00 + 1210.00 + 1100.00 + 1000.00. That assumes a $1000 payment at the end of the eighth year. The total is 11,435.89 extra after 8 years, compared to $12,000 for option B. Go with B. Many people would choose A anyway, for the benefit of more current income.

Thanks so much. I reviewed what you listed and it actually made sense. That was very helpful.

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