You are considering two insurance settlement offers. The ﬁrst offer includes annual payments of $5,000, $7,500, and $10,000 over the next three years, respectively. The other offer is the payment
Of one lump sum amount today. You are trying to decide which offer to accept given the fact that
Your discount rate is 5%. What is the minimum amount that you will accept today if you are to select
The lump sum offer?

Question

Quizplus · Accepted Answer

The present value of the annual payments can be calculated using the formula PV = CF1 / (1+r)^1 + CF2 / (1+r)^2 + CF3 / (1+r)^3, where CF1, CF2, and CF3 are the cash flows in each year and r is the discount rate (5%). Plugging in the values, we get PV = 5000 / (1+0.05)^1 + 7500 / (1+0.05)^2 + 10000 / (1+0.05)^3 = $21,032.95. Therefore, the lump sum offer should be at least $21,032.95 to be equivalent to the annual payments. The closest option is B: $20,203.00, but it is still below the minimum amount required, so the best choice would be to reject both offers.

You Are Considering Two Insurance Settlement Offers