Rehan has been awarded some money in a settlement. He has the option to take a lump sum payment of $170,000 or get paid an annuity of $1,000 per month for the next 20 years. Which is the better deal for Rehan, and by how much, assuming the growth rate of the economy is 3.05% per year?
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There are two options available:
1. Take $170,000 now: or
2. Get an annuity of $1,000 every month for 20 years which is 240 months. First annuity you will get now (time period = 0) and the last annuity you will get at the beginning of period 240 (or end of period 239). The discount rate is 3.05% per year. So the present value of all future cash flows (annuity) would be $179,956.
Compairing both the options, it appears the present value of annuity is $179,956 whereas present value in case of option 1 is $ 170,000. Therefore, it can be concluded that option 2 (annuity) is better since its present value is higher.