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You are the beneficiary of a life insurance policy
You are the beneficiary of a life insurance policy. The insurance company informs you that you have two options for receiving the insurance proceeds. You can receive a lump sum of $120,000 today or receive payments of $1,200 a month for 8 years. You can earn 5.5 percent on your money. Which option should you take and why?
Expert Solution
1) Option 1st: Taking Lump sum Amount
Present Value of the Lump Sum Payment would be $120,000 ie, the total value of the amount received now.
"Hence, the Present Value of the Lump Sum Payment will be $120,000"
2) Option 2nd: Taking Monthly payment of $1,200 per month for next 8 years
Computation of Present Value of Annuity using PMT Function in Excel:
=-pv(rate,nper,pmt,fv)
Here,
PV = Present Value of Annuity = ?
Rate = 5.5%/12
Nper = 8 years*12 months = 96 months
PMT = $1200
FV = 0
Substituting the values in formula:
=-pv(5.5%/12,96,1200,0)
PV or Present Value of Annuity = $93,028.14
We should choose the "Lump sum method" for the receiving the payment, Since the Present Value of the future cash payment is higher in Lump sum method ($120,000) as compared to the present value under annuity payment method ($93,028.14).
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