1.) Eichelberger Trucking won a settlement in a lawsuit and was offered four dif

Question

1.) Eichelberger Trucking won a settlement in a lawsuit and was offered four different payment alternatives by the defendant’s insurance company. The interest rate is 8%. Ignoring the tax considerations, which of the following four alternatives has the highest present value (and thus is the best option)? Support your answer with the appropriate calculations. 1) $180,000 now. 2) $70,000 per year for the next 4 years (end-of-year payments) 3) $15,000 now and then $33,000 per year for the next 10 years (end-of-year payments). Hint: Calculate the present value of the initial $15,000 separately. Then calculate the present value the $33,000 annuity separately. Finally, add the two present value amounts together to get the overall present value. 4) $17,000 per year for the next 10 years (end-of-year payments) plus a lump sum payment of $245,000 at the end of the 11th year. Hint: Calculate the present value of the $17,000 10-year annuity separately. Then calculate the present value the $245,000 payment received at the end of year 11 separately. Finally, add the two present value amounts together to get the overall present value.

Explanation / Answer

1) $ 180,000 right now will have an equivalent present value of $ 166,666.67 2) Getting $ 70,000 per year for the next four years will fetch a present value of $ 231,848.88 3) Getting $ 15,000 right now will have a present value of $ 13,888.89 The $ 33,000 per year for the next 10 years will have a present value of $ 221,432.69 Combining the two present values gives us a total present value of $ 235,321.58 4) Getting $ 17,000 per year for the next 10 year will have a present value of $ 114,071.38 The present value of the down payment of $ 245,000 received at the end of year 11 $ 226,851.85 Combining the two present values gives us a total present value of $ 340,923.23 From the valuations shown, it can be inferred that option 4 has the highest present value, and hence is the best option.

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