How to Calculate Lump Sum Vs. Lifetime Payments
Finance is the study of cash flows. Cash flows can be periodic or in one lump sum. While it might seem that $100 paid out at the end of the next 10 years is equal to $1,000 today, it is not. This is because of a concept referred to as the time value of money, or TVM. As a result, there are formulas that financial analysts use to determine the difference between a lump sum payment today (present value) and lifetime payments.
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Instructions
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Estimate the number of years for a lifetime payment. This varies per person. Assume that each person lives 90 years. So if you're 60 years old, lifetime payments means 30 more years. If you're 30 years old, lifetime payments means 60 years. Assume you are 60 years old.
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Identify the payment amount. Assume the payment amount is $100,000 at the end of the year for the next 30 years.
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Determine the prevailing interest rates. This depends on the economy at the time. You can use the rate for 10-year Treasury Bonds as an estimate; this can be found on the cover of the business section of your newspaper or by calling your banker. Assume the prevailing interest rate is 5 percent.
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Look up the present value annuity factor. There are tables that actuaries and financial analysts use to determine the present value of a lifetime of payments. See Resources for a link. "n" stands for the number of years, and "i" is the prevailing interest rate. You want the number which is at the intersection of "n" and "i." For this example, "n" is 30 and "i" is 5 percent. The factor is: 15.372.
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Multiply the payment amount by the factor for the present value of lifetime payments. The calculation is $100,000 multiplied by 15.372 or $1,537,200. This is the amount you will be paid in one lump sum today versus the amount you will be paid by taking lifetime payments, which in this case equals $100,000 multiplied by 30 or $3 million.
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References
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