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TVM Assignment

John received a lump sum settlement of $2,330,716 based on tables calculating the present value of an annuity for someone earning $200,000 annually over 25 years at a 7% interest rate. These tables make calculations easier for situations like insurance payouts, allowing recipients to receive lump sums upfront rather than annual payments. John's settlement represents the total value of payments over 25 years and is fair based on the assumed 7% rate. However, the deal could be good or bad depending on whether future interest rates are higher or lower than 7%. Considering individual factors like paying off high interest debt, the lump sum provides John flexibility and may be the best option for his situation. The time value of money is relevant

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224 views

TVM Assignment

John received a lump sum settlement of $2,330,716 based on tables calculating the present value of an annuity for someone earning $200,000 annually over 25 years at a 7% interest rate. These tables make calculations easier for situations like insurance payouts, allowing recipients to receive lump sums upfront rather than annual payments. John's settlement represents the total value of payments over 25 years and is fair based on the assumed 7% rate. However, the deal could be good or bad depending on whether future interest rates are higher or lower than 7%. Considering individual factors like paying off high interest debt, the lump sum provides John flexibility and may be the best option for his situation. The time value of money is relevant

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TIME VALUE OF MONEY

1. Johns lump sum was determined using the factor from the Present Value of
a regular Annuity table.
Assuming that John was earning $200,000 a year and he could work 25 more
years until age 65, they pulled the factor from the table for 25 periods and
the 7% interest rate that was assumed (which is 11.65358) and multiplied the
$200,000 by that factor. That is where the lump sum of $2,330,716.
These tables with factors are created to do the math easy. An example of
why these are needed could be something like if an insurance company
agreed to pay a person $1,000 for say 10 years, so they would pay $1,000 in
year one, year two on to year 10 for a total of $10,000.
If the insurance were to pay the $10,000 up front, and a fair interest rate
were 5% or so, then after the first year alone, the person would have
$10,500, after the second year they would have $11,025, then they would
have $11,576 and at the end of the 10 years, the person could have about
$16,300 just by letting their bank account get interest.
Because of things like this and to provide people the flexibility to people to
get their payments earlier, they have come up with the factors and that is
how Johns lump-sum payment was calculated.
2. Johns settlement is fair based on the 7% interest rate. The payment he
received should be able to turn into the total amount of all the payments if he
were to just let the money acrew interest. John now has the freedom to do
other things with money that he would not have had in the future.
Whether or not this is a good deal will depend on the market interest rates
and Johns life situation. If the rates climb higher than 7%, then it would be a
great deal for John as he can earn higher interest and his end sum could be
more than if he just took the annual payments. If the rates drop, then he
could get a bad deal, because then the interest that he could acrew would
not get him close to the amount of his total payments had he just taken
those.
Because of the lump sum though, if John has some bills like a higher-rate
(maybe 18% credit card) that he can pay off, then this is a GREAT situation
the best way for him to go because then he can pay that off and not pay
someone else 18% interest. (It would even be better for John to receive a
little less than the fair amount if it helped him pay off the credit card debt.
This is why he is getting a fair deal.
3. This study fits into my study as the Time Value of Money is something that
should be thought of in every aspect of accounting.
Because of TVM, even prepaying expenses can lose interest revenue (albeit
very low income). TVM also helps a company decide how valuable it can be to

take advantage of discounts when it is an account payable, and when you


have an account receivable, it can help determine if a discount should even
be offered to someone for paying the AR earlier or just waiting it out for the
higher payment.
TVM becomes more prevalent in longer-term investments, but either way;
TVM can affect almost any decision that is made with paying or receiving
money.

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