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Respond to the items below. Part A: Given the following cash inflow at the end of each year, what is the future value of this cash flow at 6%, 9%, and 15% interest rates at the end of the seventh year? Year 1 $15,000 Year 2 $20,000 Year 3 $30,000 Years 4 through 6 $0 Year 7 $150,000 Part B: County Ranch Insurance Company wants to offer a guaranteed annuity in units of $500, payable at the end of each year for 25 years. The company has a strong investment record and can consistently earn 7% on its investments after taxes. If the company wants to make 1% on this contract, what price should it set on it? Use 6% as the discount rate. Assume that it is an ordinary annuity and the price is the same as present value. Part C: A local government is about to run a lottery but does not want to be involved in the payoff if a winner picks an annuity payoff. The government contracts with a trust to pay the lump-sum payout to the trust and have the trust (probably a local bank) pay the annual payments. The first winner of the lottery chooses the annuity and will receive $150,000 a year for the next 25 years. The local government will give the trust $2,000,000 to pay for this annuity. What investment rate must the trust earn to break even on this arrangement? Part D: Your dream of becoming rich has just come true. You have won the State of Tranquility’s Lottery. The State offers you two payment plans for the $5 million jackpot. You can take annual payments of $250,000 for the next 20 years or $2,867,480 today. a. If your investment rate over the next 20 years is 8%, which payoff will you choose? b. If your investment rate over the next 20 years is 5%, which payoff will you choose? c. At what investment rate will the annuity stream of $250,000 be the same as the lump sum payment of $2,867,480?

Paper For Above instruction

The financial decisions surrounding cash inflows, investments, and annuities are fundamental aspects of personal and institutional finance. This paper explores various scenarios involving future value calculations, valuation of annuities, investment break-even rates, and comparative analysis of payment options, providing comprehensive insights into each situation based on established financial principles.

Part A: Future Value of Cash Inflows at Different Interest Rates

In financial planning, understanding the future value (FV) of a series of cash inflows is essential. Given the cash inflows for different years, calculating the FV at specified interest rates involves compounding each cash flow to the end of the seventh year. The cash inflows are as follows: $15,000 at the end of Year 1, $20,000 at the end of Year 2, $30,000 at the end of Year 3, no inflows from Years 4 through 6, and $150,000 at the end of Year 7.

To compute FV at the end of Year 7, each cash flow must be compounded forward using the formula:

FV = PV × (1 + r)^n

where PV is the present value of each cash inflow, r is the interest rate, and n is the number of periods remaining until Year 7.

Calculations at different rates show the significance of interest compounding. For instance, at 6%, the future value accounts for the growth of each cash inflow over its respective period, reflecting the lower interest accumulation compared to higher rates such as 15%.

Part B: Valuation of a Guaranteed Annuity

Counting on a stable 7% return, County Ranch Insurance aims to set a price for a guaranteed annuity. This annuity has units worth $500, payable annually for 25 years, with the company desiring a 1% profit over the discounted value. The key to determining the fair price is calculating the present value (PV) of an ordinary annuity with a payment of $500, discounted at 6%, which incorporates the company's profit margin.

The PV of an annuity can be computed using the formula:

PV = P × [1 - (1 + r)^-n] / r

where P is the payment, r is the discount rate, and n is the total number of payments. Adjusting for the profit margin involves adding 1% to the PV calculation or directly incorporating it into the price setting process.

Part C: Breakeven Investment Rate for a Trust

The local government funds an annuity with a $2,000,000 payment to the trust, which will pay $150,000 annually for 25 years. The question is: what rate must the trust earn to break even? Here, the trust's investment earnings must match the present value of the payments, which is $2,000,000. Using the present value of an ordinary annuity formula, solving for the interest rate (r) involves iterative methods or financial calculator functions to find the rate at which the PV equals $2,000,000, given the payment and period length.

Part D: Comparing Lump Sum and Annuity Options

Choosing between an annuity of $250,000 annually for 20 years or a lump sum of $2,867,480 requires analyzing the present value of the annuity at different investment rates (8% and 5%) and comparing with the lump sum. The present value of the annuity depends on the discount rate used, computed as:

PV = P × [1 - (1 + r)^-n] / r

where P = $250,000, n = 20 years, and r varies. The investment rate influences which payment option yields the higher value. Additionally, calculating the break-even rate where both options are equal involves solving for r in the PV equation when PV of the annuity equals the lump sum.

Conclusion

The scenarios discussed demonstrate essential financial principles such as future value calculations, annuity valuation, breakeven investment rates, and comparative analysis of payment streams. Mastery of these concepts enables effective financial decision-making in personal investments, insurance products, and public financial management.

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