You have the opportunity to purchase an insurance policy for your newborn son.You must make the payments shown in the table.After his fifth birthday no more payments are required.If your son reaches the age of 60,then the insurance company will pay him $90,000.Alternatively,you could invest the money in a savings account.Your banker promises to pay you interest at the rate of 8% for the first 5 years (from now until your son's fifth birthday),but only promises 4% every year after that.Should you buy the policy or invest in the savings account?

A) Yes, buy the policy.
B) No, do not buy the policy.
C) The policy and the savings account have the same future value.

Question

You have the opportunity to purchase an insurance policy for your newborn son.You must make the payments shown in the table.After his fifth birthday no more payments are required.If your son reaches the age of 60,then the insurance company will pay him $90,000.Alternatively,you could invest the money in a savings account.Your banker promises to pay you interest at the rate of 8% for the first 5 years (from now until your son's fifth birthday) ,but only promises 4% every year after that.Should you buy the policy or invest in the savings account?

A) Yes, buy the policy. 
B) No, do not buy the policy. 
C) The policy and the savings account have the same future value.

Quizplus · Accepted Answer

Step 1 - Take the future value of each cash flow and then add them together:
FV = PV × 11ea7fdb_fc2a_a55b_a768_4dd3f8dba1a8_TB2902_00 FV = 600 × (1.08 11ea7fdb_fc2a_cc6c_a768_ab13d6c0c15f_TB2902_00 = $816.29
FV = 650 × (1.08 11ea7fdb_fc2a_cc6d_a768_310573215a13_TB2902_00 = $818.81
FV = 700 × (1.08 11ea7fdb_fc2a_cc6e_a768_e93c2a357687_TB2902_00 = $816.48
FV = 750 × (1.08 11ea7fdb_fc2a_cc6f_a768_6924f85d3037_TB2902_00 = $810
816.29 + 818.81 + 816.48 + 810 + 800 = $4,061.58
Step 2 - Use the future value of the first five birthday cash flows to find the future value of the remaining fifty-five years.
FV = 4,061.58 × (1.04 11ea7fdb_fc2a_cc70_a768_8994bcd37bd0_TB2902_00 = $35,117.91
$35,117.91 < $90,000 so take the policy

You Have the Opportunity to Purchase an Insurance Policy for Your