Congratulations You have won a prize of 48000 But you must d

Congratulations! You have won a prize of $48,000. But, you must decide whether to receive $8,000 at the end of every year for 6 years, or to receive $4,000 at the end of every 6 months for 6 years. Assume an annual interest rate of 16%. Calculate the present value of each alternative, and indicate which alternative you would prefer.

Solution

Solution:

Alternative-1

The present value of $8,000 annually for 6 periods discounted at 16% is = $8,000*CDF(6,16%)

   = $8,000*3.685 = $29,480

Alternative-2

The present value of $4,000 semi-annually for 12 periods discounted at 8% is = $4,000*CDF(12,8%)

   = $4,000*7.536 = $30,144

Therefore, the alternative-2 is preferred instead of alternative-1.

Note: CDF denotes Cumulative Discount Factor