Problem 11-3 Effect of discount rate [L03 A brilliant young scientist is killed
ID: 2615239 • Letter: P
Question
Problem 11-3 Effect of discount rate [L03 A brilliant young scientist is killed in a plane crash. It is anticipated that hecould have earned $240,000 a year for the next 50 years. The attorney for the plaintiff's estate argues that the lost income should be discounted back to the present at 4 percent. The lawyer for the defendant's insurancecompany argues for a discount rate of 8 percent. What is the difference between the present value of the settlement at 4 percent and 8 percent? Compute each one separately. Use Appendix D for an approximate answer but calculate your final answer using the formula and financial calculator methods. (Do not round intermediate calculations. Round your answers to 2 decimal places.) Input variables: $240,000 Annual income Number of years Plaintiffs discount rate Defendant's discount rate Appendix plaintiff's factor Appendix defendant's factor 50 years 0.04 0.08 21.482 12.233 Solution and Explanation: PV at plaintiff's rate PV at defendant's rate Difference Appendix values: PV at plaintiff's rate PV at defendant's rate DifferenceExplanation / Answer
Calculator Solution:
Answer = $5,155,724.31
PV at defendant's rate
0
Answer: $2,936,036.31
PV at 4% rate $5,155,724.31
PV at 8% rate 2,936,036.31
Difference $2,219,687.99
Appendix Values:
Present Value at 4%
PVA= A × PVIFA(4%, 50 periods) Appendix D
PVA= $240,000 × 21.482 = $5,155,680
Present Value at 8%
PVA= A × PVIFA(8%, 50 periods) Appendix D
PVA= $240,000 × 12.233 = $2,935,920
PV at 4% rate $5,155,680
PV at 8% rate 2,935,920
Difference $2,219,760
N I/Y PV PMT FV 50 4 CPT PV -5,155,724.31 240,000 0