Question

Under the terms of his salary agreement, president Steve Walters has an option of receiving either an immediate bonus of $71,500, or a deferred bonus of $91,000 payable in 10 years. Click here to view factor tables Ignoring tax considerations and assuming a relevant interest rate of 4%, which form of settlement should Walters accept?

Answer 1

Answer: Walters should accept the immediate bonus of $71,500. See explanation below.

Explanation: In order to determine the better form of settlement, we will have to calculate the present value of $91,000 payable in 10 years, at a 4% interest rate and compare the answer with $71,500.

The formula for calculating present value (PV) is given as:

PV = C/(1 + r)^n

Where;

C = amount of money payable ($91,000)

r = percentage interest rate (4%)

n = number of years (10 years)

PV = 91,000/(1 + 0.04)^10

PV = 91,000/(1.04)^10

PV = 91,000/1.48

PV = 61,486.486

Therefore, the present value of $91,000 payable in 10 years at a 4% interest rate is approximately $61,486.50. This value is lesser than $71,500.

Hence, the form of settlement that Walters should accept is an immediate bonus of $71,500.