TVM Assignment acct2310
On a rainy afternoon two years ago, John Smiley left work early to attend a family birthday party. Eleven minutes later, a careening truck slammed into his SUV on the freeway causing John to spend two months in a coma. Now he can't hold a job or make everyday decisions and is in need of constant care. Last week, the 40-year-old Smiley won an out-of-court settlement from the truck driver's company. He was awarded payment for all medical costs and attorney fees, plus a lump-sum settlement of $2,330,716. At the time of the accident, John was president of his family's business and earned approximately $200,000 per year. He had anticipated working 25 more years before retirement. John's sister, an acquaintance of yours from college, has asked you to explain to her how the attorneys came up with the settlement amount. “They said it was based on his lost future income and a 7% rate of some kind,” she explained. “But it was all ‘legal-speak‘ to me.”
Complete Analysis How was the amount of the lump-sum determined? Create a calculation that might help John’s sister understand.
The lump-sum was determined by using the Present Value of Ordinary annuity.
The settlement John received was calculated by taking the amount he would have received from his employer of $200,000 every year at the end of the period for 25 years at a 7% interest rate.
To find this amount, table 4 was used– Present Value of an Ordinary Annuity of $1.
N=25
I=7%
Table factor = 11.65358
$200,000 multiplied by 11.65358 is $2,330,716
The lump-sum settlement awarded is $2,330,716
I then verified this amount on my BA II calculator by entering the figures below:
200,000 PMT key
25 N key
7 I Key
CPT PV = 2,330,716
Was the settlement fair? Explain.
Yes, the settlement was fair. John received the amount he would have received if he were able to continue working at the amount that would be equal to today. He was also awarded payment for medical bills and attorney fees. Even though the amount is fair at today’s value, there is a possibility that it could be unfair in the future. John’s income could have increased as employers usually offer periodic raises.
Write a brief reflection on how this assignment fits into your program and prepares you for your field of study.
Time value of money (TMV) is an important concept in all parts of business. Present value determines what cash received in the future is worth today. Future value determines what cash received today is worth in the future. The time value of money concept is useful when solving many business decisions. The concepts are significant when valuing assets and liabilities for financial reporting purposes. You will need to know the time value of money to valuate leases, bonds, pension obligations, notes receivable and payable in an accounting career. TMV is a very important requirement in the accounting field.
