Question

Provide Sue with financial advice on which option has the potential to yield the highest monetary value. Support your rational with calculations using time value of money and comment on the risk return relationship for each option, assume interest rate on savings is 4% and is compounded semi-annually.

Sue James is a 55-year old accountant who works at Ernst and Young (EY) who is about to retire. She has the following decision to make:

Option A – Select a lump sum gratuity payment of $120,000 with a reduced pension of $1,750 per month.

Option B – Select a monthly pension of $3,300 with no lump sum gratuity payment.

In addition, Sue has a loan of $72,000 with loan payments of $1,200 per month for the next five years.

Answer 1

Page-1 Answer: As per the given question, the financial advice is as follows: EAR = (14]. )n 2013 404. Monthly interest rate= 4:04% 20.337% 12 Option-A:- - He could sepay the loan with the lumpsum amount of $120,000 and enjoy $ 1750 /month pension... → Value of lumpsum amount of ter te-payment of loan = ($13,0000 -72000,)=$45,000 → Present value of $1750 /month annuity in perpetuity cash flow 1. Interest rate = $1750 0.337 = $519802

Page-2 → Present value of total net pension benefit = $48000 +$ 519 502 oli = $ 567502 Option- B:- He will sepay $1200 each month for his loan and he will have (3300-1200) - $2100 ofter loan cash inflow. The present value of $2100/month for 5 year is $ 113,916.35. Calculation is given below: - PMT NPER 1 2100 I 60 0.337%. PVC B3, B2,B1) Rate PV

Page-3 IPMT 2100 60 NPER Rate 0337" $113,916.36 PV * After 5 year he will get $3300 in full per month * After 5 year, present value of this perpetwrity amount - 3300 0.337°% = $980,198 ay present value of total benefit - 113916.36+ 980198 T+4.04°10 = $91802011 As the net present vake of option B is more than optiona. He should choose option B. - X -