Question

Question:

You participate in a jury. Today a worker sued the city for the injuries suffered due to an accident with a street sweeper truck. At the trial, the doctors declare that the plaintiff will be able to return to work in five years. The jury has already ruled in favor of the plaintiff. You are the judge of the jury and propose the jury to grant today a compensation to the plaintiff. The compensation covers the following:

1. A retroactive payment equivalent to the salary of the last two years. The annual salary (monthly salary*12) of the plaintiff during the last two years would have been $40,000 (two years ago) and $43,000 (one year ago), respectively.

2. The present value of the future monthly salary for the next eight years. You assume that the salary will be $45,000 per year (monthly salary*12) for the first five years, and then $48,000 (monthly salary*12) for the next three years.

3. A payment today for the amount of $100,000 due to pain and suffering.

4. Finally, a payment of $20,000 today to cover court costs. Assume that salary payments are of equal amounts paid at the end of each month, except in the last three future years where salaries are equal but paid at the beginning of each month. It is estimated that the appropriate interest rate is 18% nominal biennial with monthly capitalization. (a) What is the amount of the retroactive payment which will be paid to the plaintiff today? (b) What is the total amount of compensation that will be paid to the plaintiff today? (c) If you were the plaintiff, would you like to use a higher or lower interest rate? Explain.

Answer 1

Answer 3: If I were the plaintiff I would have chosen lower interest rate as the Present Value (PV) is inversely proportional to rate of interest and therefore, in that case, the total amount of compensation would have been more whereas the loss in calculating the future value to arrive at retroactive payment had not been significant as it is only for last two years with little impact of time value of money.