Susie has been offered four choices regarding an insurance settlement spanning 1

Question

Susie has been offered four choices regarding an insurance settlement spanning 10 years. If the interest rate is 8% per year compounded quarterly, which contract is the best (in pure economic terms)?

A) Immediate cash payment of $2 million followed by $2 million at the end of years 3, 6 and 10

B) Immediate cash payment of $500,000 followed by $200,000 per quarter for next 10 years (payments made end of quarter)

C) Only one cash payment of $5.5 million today.

D) Only one cash payment of $13.5 million at the end of 10 years.

Explanation / Answer

so we are calculate the present value of all choices , interest rate = 8%, compounded quarterly, period = 10 years

A) present value of future cash flows

b) total cash payments of b option= $ 500,000+present value of annuity factorof 40 periods @2%*$ 200000

= $ 500,000+27.355479*$ 200,000

=$ 5,971,095.8

c)$ 5,500,000

d)present value of cash flow= $ 13,500,000*0.452890415

=$ 5,887,575.39

so in this four options offer b is the better because of highes cash floes of today

year periods cash flow discount factor@ 8%/4=2% product 0 0 $ 2,000,000 1 $ 2,000,000 3 3*4=12 $ 2,000,000 0.78849317 $ 1576986.35 6 6*4=24 $ 2,000,000 0.621721487 $ 1,243,442.97 10 10*4=40 $ 2,000,000 0.452890415 $ 905,780.83 total $ 5,726,210.10

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