Your trust fund will pay you $100,000 in six years when you turn 25.A shady financial institution has encouraged you to sign away the rights to your trust fund in exchange for cash today.Would you prefer that the financial institution use a discount rate of 8% or 10% to determine the value of your lump sum payment? Why?
A)Use 8% because the lump sum payment of $62,741 is greater than the 10% discounted value of $55,839.
B)Use 10% because the lump sum payment of $62,741 is greater than the 10% discounted value of $55,839.
C)Use 8% because the lump sum payment of $63,017 is greater than the 10% discounted value of $56,447.
D)Use 10% because the lump sum payment of $63,017 is greater than the 10% discounted value of $56,447.

Question

Quizplus · Accepted Answer

Using an 8% discount rate, the present value of the trust fund is $37,278.64 ((100,000/(1+.08)^6)). With this discount rate, the financial institution would offer a lump sum payment of $63,017, which is greater than the 10% discounted value of $56,447. Therefore, it is better to use the 8% discount rate in order to receive more money.

Your Trust Fund Will Pay You $100,000 in Six Years