A lump sum is a single payment of money, as opposed to multiple payments over time. It is often used in financial contexts where the time value of money is considered.
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Lump sums are often compared to annuities, which involve a series of equal payments over time.
The present value of a lump sum can be calculated using the formula PV = FV / (1 + r)^n, where PV is present value, FV is future value, r is the discount rate, and n is the number of periods.
Receiving a lump sum today is generally more valuable than receiving the same amount in the future due to the time value of money.
Lump sums are commonly used in scenarios like lottery winnings, retirement payouts, and settlements.
When deciding between a lump sum and an annuity, factors such as interest rates, inflation, and individual financial needs must be considered.
Review Questions
What formula do you use to calculate the present value of a lump sum?
Why might someone prefer receiving a lump sum today rather than an equal amount spread over several years?
In what scenarios might you encounter lump sum payments?
Related terms
Annuity: A series of equal payments made at regular intervals over a specified period.
Present Value: The current worth of a future sum of money or stream of cash flows given a specified rate of return.
Time Value of Money: The concept that money available now is worth more than the same amount in the future due to its earning potential.