Question

1. Calculate the present value of each of the alternatives below, if the discount rate is 12%.

a. $45,000 today in one lump sum.

b. $70,000 paid to you in seven equal payments of $10,000 each at the end of each of the next seven years.

c. $80,000 paid in one lump sum 7 years from now.

2. You are negotiating for the terms of a legal settlement, and your opponent’s attorney has presented you with the following alternative settlement alternatives:

a. $38,000 today in one lump sum.

b. $50,000 to be paid to you in five equal payments of $10,000 at the end of each of the next five years.

c. If your discount rate is 10%, what is the present value of each of the alternatives and which alternative would you choose, and why?

Answer 1

1. a. Present Value = $45,000

b. Present Value = Annuity * [ {1 - (1 + r)^(-n)} / r]

= 10000 * [{1 - (1 + 0.12)^(-7)} / 0.12)]

= 10000 * 4.563757 = $45,637.57

c. Present Value = Future value / ( 1+r) ^n

= 80000 / (1+0.12)^7 = $36,187.94

Best alternative is Option B. because it has highest present value.

2. a. Present value = $38,000

b. Present Value = Annuity * [ {1 - (1 + r)^(-n)} / r]

= 10000 * [{1 - (1 + 0.10)^(-5)} / 0.10)]

= 10000 * 3.790787 = $37,907.87

Best alternative is Option A. because it has higher present value.