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corporate finance

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

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SHALLY

  1. Interest rate on what? Is that figuring the interest rate you can get on $250,000 for five years?

    This is an ambiguous question.

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    Ms. Sue

  2. 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.

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    SHALLY

  4. 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?

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    Anonymous

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