Question

You are the beneficiary of a life insurance policy. The insurance company offers two options for receiving the proceeds: a lump sum of $50,000 today or payments of $550 a month for ten years. If you can earn 6 percent, compounded monthly, which option should you take and why?

a. You should accept the lump sum because the payments are only worth $49,540.40 today.

b. You should accept the payments because they are worth $51,523.74 today.

c. You should accept the payments because they are worth $53,737.08 today.

d. You should accept the $50,000 because the payments are only worth $49,757.69 today.

e. You should accept the $50,000 because the payments are only worth $48,808.17 today.

Answer 1

Answer is a.

Insurance company is offering two options:
Option 1: $50,000 today
Option 2: $550 per month for 10 years

Option 1:

Present Value = $50,000

Option 2:

Monthly Payment = $550
Annual Interest Rate = 6%
Monthly Interest Rate = 0.5%

Present Value = $550/1.005 + $550/1.005^2 + $550/1.005^3 + .... + $550/1.005^120
Present Value = $550 * (1 - (1/1.005)^120) / 0.005
Present Value = $49,540.40

So, Ooption 1 should be selected because the payments are only worth $49,540.40 today.