A financial company that advertises on television will pay you $56,000 now for annual payments of...

Question:

A financial company that advertises on television will pay you $56,000 now for annual payments of $9,500 that you are expected to receive for a legal settlement over the next 9 years. Assume you estimate the time value of money at 12 percent. What is the present value? Would you accept this offer?

Annuity

An annuity is a series of equal cash flows (either incoming or outgoing) which will occur at regular intervals in the future. The present value of these cash flows can be calculated based on a formula.

Answer and Explanation: 1

While it is not specifically stated in the problem, we will assume that the annual payments of $9,500 will occur at the beginning of each year, so that the cash flows represent an annuity due.

The formula for the present value of an annuity due is:

where:

  • PV = present value
  • P = amount of periodic payment
  • r = interest rate
  • n = number of payments

So, for the legal settlement, the inputs are:

  • P = $9,500
  • r = 12%
  • n = 9

and the formula is:

So, the present value of the legal settlement is $56,693.

Since that amount is greater than the amount offered on TV by the financial company, you would not accept the offer.


Learn more about this topic:

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How to Calculate the Present Value of an Annuity

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Chapter 8 / Lesson 3
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Learn how to find present value of annuity using the formula and see its derivation. Study its examples and see a difference between Ordinary Annuity and Annuity Due.


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