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Which one would you rather have: a) The future value of $5,000 per year for 10...

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Finance

Which one would you rather have:

a) The future value of $5,000 per year for 10 years to be givento you in year 10 (that is 10 years from now) when the interestrate is 6%?

b) The present value of $12,500 per year from year 11 to year 35when the interest rate is 6%?

Answer & Explanation Solved by verified expert
3.6 Ratings (540 Votes)

The question is based upon time value of money.
The alternative which has higher time value of money at the same time will be choosen.
a) Value of cash flows 10 years from now = Annual cash flows * Future value of annuity of 1 for 10 years
= $             5,000 * 13.18079
= $     65,903.97
Working:
Future value of annuity of 1 for 10 years = (((1+i)^n)-1)/i Where,
= (((1+0.06)^10)-1)/0.06 i 6%
= 13.18079494 n 10
b) Value of cash flows 10 years from now = Annual cash flows * Present value of annuity of 1
= $           12,500 * 12.78336
= $ 1,59,791.95
Working:
Present value of annuity of 1 = (1-(1+i)^-n)/i Where,
= (1-(1+0.06)^-25)/0.06 i 6%
= 12.78335616 n 25
Value of money 10 years from now is better in option b.So, option (b) should be selected.

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