You win a prize at your sorority and you are given the following two payoff options: Option 1 is to receive $100 one year from today and $100 two years from today. Option 2 is to receive $180 today. If the annual interest rate is 5%, the present value of option 1 is:
A)$176.56.
B)$185.94.
C)$190.48.
D)$195.24.

Question

Quizplus · Accepted Answer

To determine the present value of option 1, we need to discount the future cash flows back to present value using the annual interest rate.

PV of $100 one year from today = $100/(1+0.05)^1 = $95.24
PV of $100 two years from today = $100/(1+0.05)^2 = $90.70

Therefore, the present value of Option 1 = $95.24 + $90.70 = $185.94

Comparing the present value of option 1 and option 2, we see that option 2 offers $180 today, which is greater than the present value of option 1 ($185.94). Therefore, the best choice is Option 2, to receive $180 today.

You Win a Prize at Your Sorority and You Are