Answer:
The first option of an annuity is better because the amount is worth $2,288,098 in today's cash
Explanation:
The better choice would be the option with the higher present value discounted at the required rate of return. The required rate of return is 8%.
To determine the better choice, we would compare the present value of choice 1 to the $500, 000 receivable today under choice 2
The present value of $50 000 at the end of each year for 20 years is
PV = A × ((1+r)^n - 1)/r
r- 8%, n - 20, A= 50,000, PV - Present value
PV = 50,000 × ( ( 1.08)^(20) - 1) /0.08
= 50,000 × 45.7619643
= $2,288,098
The first option of an annuity is better because the amount is worth $2,288,098 in today's cash which is higher than $500,000 offered by the second option.
The first option is greater than the second by $1,788,098.21 i.e
$2,288,098 - $500,000
