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Neil D. Ammen BM 222 (Financial Management) 2007-90001 March 12, 2016
Problem 1 Policy A:
To receive annual payments of P10,000 for 10 years, 35 years from now; 6% interest rate
PV(n) = FV / (1+r)^n
(1.06^35)
(1.06^36)
(1.06^37)
(1.06^38)
(1.06^39)
(1.06^40)
(1.06^41)
(1.06^42)
(1.06^43)
(1.06^44)
→ 770.09 PV → 10,150.
Policy B: to receive a lump sum of P100,000 in 40 years from now; 6% interest rate
PV(n) = FV / (1+r)^n
→ 100,000 / (1 + 0.06)^
PV → 9,722.
Verdict :
Based from the calculated present values of the two options, policy B appears to be
more attractive since Policy B's present value is only 9,722.22 which is lower than policy A's present value of 10,150.41.
In making my decision, however, I must consider my future condition either 35 or 40 years from now, i.e., 63 or 68 years old, respectively. Although the annual amount with policy A is quite smaller than that of policy B, the former will allow me to enjoy receiving the amount five years earlier than policy B. Moreover, at the age of 68 I cannot be so sure I could still be able to enjoy the lump sum of P100,000. So, with a negligible difference of P428.19 at present, I would choose Policy A.
Problem 2
Service worth 8,500 OC is 8%
Friend's Offer:
2 → 3000 / 1.08^2 → 2,669.
3 → 2000 / 1.08^3 → 1,587.
4 → 1000 / 1.08^4 → 735.03 PV → 8,696.
FV of 8,500 in 4 years: 8500 X 1.08^4 FV → 11,564.
FV of mixed streams as offered by friend:
1 → 4000 X 1.08^3 → 5,038.
2 → 3000 X 1.08^2 → 3,499.
3 → 2000 X 1.08^1 → 2,160.
4 → 1000 X 1.08^0 → 1,000.00 FV → 11,698.
Verdict: Calculation of both the PV and FV of my friend's offer reveals that accepting my friend's
Expected Rate of Return (A): (0.03 + 0.06 + 0.06) 0. or 15%
Asset B Probability Returns Weighted Value
40% 5% 2.0% 20% 15% 3.0% 40% 25% 10.0% 100%
Expected Rate of Return (B): (0.02 + 0.03 + 0.10) 0. or 15%
