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28 August, 14:31

Julie has just retired. Her company's retirement program has two options as to how retirement benefits can be received. Under the first option, Julie would receive a lump sum of $150,000 immediately as her full retirement benefit. Under the second option, she would receive $14,000 each year for 20 years plus a lump-sum payment of $60,000 at the end of the 20-year period. Page 553 Required: If she can invest money at 12%, which option would you recommend that she accept? Use present value analysis.

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  1. 28 August, 14:35
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    First option will be recommended.

    Explanation:

    To determine which option to be taken, we calculate the net present value each option generates. The option generating higher NPV should be recommended.

    - Net present value of first option = Lump sum receipt = $150,000.

    - Net present value of second option will be found by discounting cash flows at investing rate 12% and calculated as followed:

    + Present value of 20 equal annual payment of $14,000 + Present value of $60,000 paid in 20 years = (14,000/12%) x [ 1 - 1.12^ (-20) ] + 60,000/1.12^20 = $110,792.

    As net present value of the first option is higher than the second option, first option will be recommended.
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