Time Value of Money and Annuity
Business & Finance

Tutor: None Selected  Time limit: 1 Day 
 create a personal scenario that exemplifies the time value of money that includes the opportunity cost involved.
 Describe one (1) reallife example that shows the manner in which a person can use an annuity for retirement planning.
A personal scenario: credit and opportunity cost
Suppose I want a
car that costs $20,000. If I've borrowed the money at 5% interest per
year, compounded annually, and I pay it back over 5 years, the amount I
will have spent on the car is $25526 total.
My next best
alternative is to save up for 5 years until I have enough money to buy
the car outright. Let's say that inflation is approximately 2%. The
$20,000 car I could have bought now will cost $22,081 in 5 years. So the
opportunity cost of buying the car right away is about $25526  22081 =
3445. However, the opportunity cost of not buying the car is having the
use of it for 5 years, plus whatever transportation expenses I incur.
A
business scenario is: I am considering investing in a retail store that
will require a $20,000 upfront investment. I want to keep the
investment for about 5 years. Looking at statistics on stores like it, I
think there is a 10% chance my investment will triple, a 20% chance my
investment will double, a 30% chance I'll break even, and a 40% chance
I'll lose the entire amount after 5 years.
In order to determine whether I should make the investment, I must calculate the expected return on investment.
(0.10 * $60000) + (0.20 * $40000) + (0.30 * $20000) + (0.40 * $0) = $20,000
The
expected value is exactly the same as my investment. However, that
doesn't mean I should make the investment. The other option is for me to
put the money into a mutual fund which historically has returned 5% per
year. After 5 years, I'd expect to have $25526. Therefore, investing in
the mutual fund has a higher expected value over time.
Describe one (1) reallife example that shows the manner in which a person can use an annuity for retirement planning.
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