Julie has just retired. Her company’s retirement program has two options as to how retirement benefits can be received.

Julie has just retired. Her company’s retirement program has two options as to how retirement benefits can be received. Under the first option, Julie would receive a lump sum of $140,000 immediately as her full retirement benefit. Under the second option, she would receive $27,000 each year for 5 years plus a lump-sum payment of $59,000 at the end of the 5-year period.

Required:

1-a. Calculate the present value for the following assuming that the money can be invested at 12%.

1-b. If she can invest money at 12%, which option would you recommend that she accept?

Explanation

The present value of the first option is $140,000, since the entire amount would be received immediately.

The present value of the second option is:

Annual annuity: $27,000 × 3.605 (Exhibit 13B-2)	$	97,335
Lump-sum payment: $59,000 × 0.567 (Exhibit 13B-1)		33,453
Total present value	$	130,788

Thus, Julie should accept the first option, which has a much higher present value.

On the surface, the second option appears to be a better choice because it promises a total cash inflow of $194,000 over the 5-year period ($27,000 × 5 = $135,000; $135,000 + $59,000 = $194,000), whereas the first option promises a cash inflow of only $140,000. However, the cash inflows under the second option are spread out over 5 years, causing the present value to be far less.

Thanks