Your mother and father are retired and need income to live on. The local financial advisor offers to sell them a product that will provide them $75,000 a year for 15 years. Prevailing interest rates are 8%. The cost to purchase the product is $750,000.
They asked you to evaluate the offer. Do you recommend they purchase the product? Why?
If prevailing interest rates were 5%, would it change your recommendation? Why?

To evaluate the choice, we have to calculate the present value of future cash flows and compare it with the cost. We use the following formula

    present value    =  C ×  [ ]

where

                     C = yearly payments = 75000

                     i =  interest rate  = 8%

                     n = no. of years   = 15

put the given values in above equation, we get

       Present value = 75000 ×8.559478688

                               = 641,961

Since the present value of cash flow 641,961 is less than the cost 750,000, I would not recommend it.

If Interest rate = 5%, then:

Do the same procedure as above but take i=5%

        Present value = 75000 × 10.37965804

                                = 778,474

Since the present value of future cash flows 778,474 is greater than the cost 750,000, I would recommend it.

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