A brilliant young scientist is killed in a plane crash. It is anticipated that h

Question

A brilliant young scientist is killed in a plane crash. It is anticipated that he could have earned $370,000 a year for the next 40 years. The attorney for the plaintiff’s estate argues that the lost income should be discounted back to the present at 5 percent. The lawyer for the defendant’s insurance company argues for a discount rate of 11 percent. What is the difference between the present value of the settlement at 5 percent and 11 percent? Compute each one separately. Use Appendix D for an approximate answer but calculate your final answer using the formula and financial calculator methods.

Explanation / Answer

Solution:

To compute the present value of the future cah flow annuity we can calculate using the formula

= 370000/(1+.11)^1 + 370000/(1+.11)^2+........ 370000/(1+.11)^40

Similarly for 5 percent

= 370000/(1+.05)^1 + 370000/(1+.05)^2+........ 370000/(1+.05)^40

Using the financial calculator we can calculate the present value annuity interest factor for 40 years 11% = 8.9511

Hence the present value for 11 % would be = 370000*8.9511 = $3311907

Similarly the present value for 5% would be = 370000*17.1591 = $6348867

Hence the difference would be = $3036960

Thank you.

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