Assume you are confronted with the following happy circumstances. Choose the alterative which makes the most sense from a financial point of view. Please do the computations even though the answer seems "obvious."
A distant relative has contacted you with a desire to help you get started with your career. She offers you your choice of $27,000 to be received in one of the following three patterns:
(1) One thousand dollars at the end of each of the first three years, starting one year from now; $3,000 at the end of each of the next three years; and $5,000 at the end of each of the last three years. Your relative suggests that this might be preferable because you are young and will need more money as you get older, not only because you will learn to spend more, but also because inflation will increase your cost of living.
(2) Three thousand dollars at the end of each of the next nine years, starting one year from now. Your relative points out that this option offers you the advantage of a steady cash flow.
(3) Five thousand dollars at the end of each of the first three years, starting one year from now; $3,000 at the end of each of the next three years; and $1,000 at the end of each of the last three years. Your relative points out that she would not recommend this option to you because it would give you an excess of cash flow during the first three years which might raise your standard of living so that it would hurt to get less in the later years.
Assume that you can expect to earn 2% rate of return. Is your relative right? Which of these options would you choose with your new acquired knowledge of time value of money?