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 chose if the interest rate is a) 0% per year; b) 8% per year and c) 20% per year
Interest rate on what? Is that figuring the interest rate you can get on $250,000 for five years?
This is an ambiguous question.
I solved it by myself :) I t was a interest rate on 350,000 !!
The retirement plan will pay $250,000 immediately ‘OR’
Pays $350,000 after 5 years from the date of retirement with:
a) Interest rate (r)=0%
Then, the PV = FV/(1+r) n
= 350,000/(1+0) 5
=$350,000
So, getting $250,000 immediately is better than getting $350,000 after five years because money value today is always higher than the money value after the years.
b) Interest rate (r)=8%
Then, the PV = FV/(1+r) n
= 350,000/(1+0.08) 5
=$238,095
So, getting $250,000 immediately is better than getting $238,095 after five years as it is not worth waiting for 5 years to get lesser money. It shows that I am going to get $238,095 now which is not good than $250,000.
c) Interest rate (r)=20%
Then, the PV = FV/(1+r) n
= 350,000/(1+0.20) 5
=$140,675
So, getting $250,000 immediately is better than getting $350,000 after five years because the value of money I am getting today will be just $140,675 which is worse.
So, from all the options, the option of getting $250,000 immediately after retirement is better than the option of getting $350,000 after 5 years with different interest rates.
You have been offered a unique investment opportunity. If you invest $10,000 today, you will receive $500 one year from now, $1500 two years from now, and $10,000 ten years from now.
a. What is the NPV of the opportunity if the interest rate is 6% per year? Should you take the opportunity?
b. What is the NPV of the opportunity if the interest rate is 2% per year? Should you take it now?
To determine which alternative is better, we need to calculate the present value of each option and compare them. The present value is the value of a future cash flow in today's dollars, taking into account the time value of money.
a) When the interest rate is 0% per year, there is no growth in the value of money over time. Therefore, both options have the same present value. You should choose based on your personal financial needs and preferences.
b) When the interest rate is 8% per year, the present value of the first option is calculated as follows:
PV = 250,000 / (1 + 0.08)^0 = $250,000
The present value of the second option is calculated as follows:
PV = 350,000 / (1 + 0.08)^5 = $271,050.74
In this case, the second option has a higher present value, so you should choose the second option.
c) When the interest rate is 20% per year, the present value of the first option is calculated as follows:
PV = 250,000 / (1 + 0.20)^0 = $250,000
The present value of the second option is calculated as follows:
PV = 350,000 / (1 + 0.20)^5 = $121,900.83
In this case, the first option has a higher present value, so you should choose the first option.
In summary, your decision should be based on the interest rate. If the interest rate is lower than 8% per year, you should choose the first option. If the interest rate is higher than 8% per year, you should choose the second option.