A Company just lost a lawsuit and now owes %5,500,000.However, they have structu

Question

A Company just lost a lawsuit and now owes %5,500,000.However, they
have structured the settlement to pay the amount 5 years fromnow.

1.Assume they have an investment that will pay 8.0 %
(compounded quarterly). What is amount each quarter they will
need to deposit to have the $5.5M in 5 years?

2.Assume they have another investment that will pay 7.5%
(compounded monthly). What is amount each month they will needto
deposit to have the $5.5M in 5 years?

3.Which option do you think is better for the company andwhy?
A Company just lost a lawsuit and now owes %5,500,000.However, they
have structured the settlement to pay the amount 5 years fromnow.

1.Assume they have an investment that will pay 8.0 %
(compounded quarterly). What is amount each quarter they will
need to deposit to have the $5.5M in 5 years?

2.Assume they have another investment that will pay 7.5%
(compounded monthly). What is amount each month they will needto
deposit to have the $5.5M in 5 years?

3.Which option do you think is better for the company andwhy?

Explanation / Answer

1.Assume they have an investment that will pay 8.0 %(compounded quarterly). What is amount each quarter theywill need to deposit to have the $5.5M in 5 years?
This is an Ordinary annuity I=8% Qtry. So each year will have 4 payments, SO i = I/p =8%/4=2% Total No of periods n = 5 *4 = 20 PMT = ??. FVA = $5.5M
Here FVA = PMT(FVIFAi,n).
FVIFAi,n = [(1+i)^n-1]/i. So FVA = 5.5M = PMT*[(1+2%)^20 - 1]/2% = 24.30*PMT So PMT = 5500000/24.30 = 226,361.95
So Qtrly payment of $226,361.95 will yield a Lumpsum of $5.5M after 5 yrs at 8% Qtrly
2.Assume they have another investment that will pay 7.5%(compounded monthly). What is amount each month they will needto deposit to have the $5.5M in 5 years?
This is an Ordinary annuity I=7.5% monthly. So each year will have 12 payments, SO i = I/p= 7.5%/12 = 0.63% Total No of periods n = 5 *12 = 60 PMT = ??. FVA = $5.5M
Here FVA = PMT(FVIFAi,n).
FVIFAi,n = [(1+i)^n-1]/i. So FVA = 5.5M = PMT*[(1+0.63%)^60 - 1]/0.63% = 72.64*PMT So PMT = 5500000/72.64 = 75,715.60
So Monthly payment of $75,715.60 will yield a Lumpsum of $5.5M after 5 yrs at 7.5% monthly
Company need to look at its cost of capital & Cash Flowsto make the investment decision. If its Cost of capital is morethan 8%, it is beter to make the inevstment at 8% Qtrly provided ithas sufficient CFs to make this investment on quarterly basis. Elseit can invest at 7.5% monthly.

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