Eichelberger Trucking won a settlement in a lawsuit and was offered four differe

Question

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 9%. 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) $52,000 per year for the next 4 years (end-of-year payments) 3) $5,000 now and then $24,000 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) $14,100 per year for the next 10 years (end-of-year payments) plus a lump sum payment of $230,000 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

Alternative 1:

Present Value = $180000

Alternative 2:

Present value of cash inflow = $52000 * Annualised annuity factor for 4 years at 9% = $52000*3.239719877 = $168465.4336

Alternative 3:

PV of 10 years payment excluding $5000 received now = $24000 * Annualised annuity factor for 10 years at 9% = $24000*6.4176577 = $154023.7848

Therefore present value = $154023.7848+$5000 = $159023.7848

Alternative 4:

Present value = ($14100*Annualised annuity factor for 10 years at 9%)+($230000*Discounting factor of 9% for 11th year) = ($14100*6.4176577)+($230000*0.38753285) = $179621.5292

Out of the four alternatives Alternative 1 has the highest Present value of $180000 and therefore Alternative 1 should be selected

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