6. Your aunt offers you a choice of $60,000 in 40 years or $850 today. If money is discounted at 11 percent, which should you choose?
I'd choose the money today. I'm not going to live another 40 years.
What would YOU do?
To determine which option to choose, we need to calculate the present value of the $60,000 offered in 40 years and compare it with the $850 offered today.
The formula to calculate the present value of future cash flows is:
Present Value = Future Value / (1 + Discount Rate)^n
Where:
- Future Value is the amount of money offered in the future
- Discount Rate is the rate at which money is discounted per period
- n is the number of periods in the future
In this scenario, the future value is $60,000, the discount rate is 11 percent (or 0.11), and the number of periods is 40 years.
Calculating the present value of $60,000 in 40 years:
Present Value = $60,000 / (1 + 0.11)^40
Using a calculator or spreadsheet, we find that the present value of $60,000 in 40 years is approximately $3,712.53.
Now, let's compare this with the $850 offered today. Since the $850 is already in present terms, we don't need to calculate its present value.
Comparing the two options:
- Present value of $60,000 in 40 years: $3,712.53
- $850 offered today.
Since $3,712.53 is significantly greater than $850, it is the better choice. Therefore, you should choose the $60,000 in 40 years over the $850 offered today.