Your annual salary is $100,000. You are offered two options for a severance package. Option 1 pays you 6 months' salary now. Opt
ion 2 pays you and your heirs $6,000 per year forever (first payment at the end of this year.) If you are required return is 11%, which option should you choose? 1. How much is the value for alternative 1?
2. How much is the value of alternative 2?
The annual salary is $100,000. You are offered two options for a severance package. Option 1 pays you 6 months' salary now. Option 2 pays you and your heirs $6,000 per year forever
The present value of option 1 is:
PV= 6*100,000= $600,000
To calculate the present value of option 2 we need to use the present value formula of a perpetual annuity:
1) We should short the contracts because we want to hedge our position in response to the expected downturn in the market, to neutralize our position we need to short the contracts.
