Your annual salary is $100,000. You are offered two options for a severance package. Option 1...

Your 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 (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?

Solutions

Expert Solution

Alternative 2 is selected as the present value of cash flows is more in alternative 2

1. Value of alternative 1 = $50000

Solution :

Value of alternative 1 = (annual salary /12)*6

= ($100000/12)*6

= $50000

2. Value of alternative 2 =

Solution :

Value of alternative 2 = present value perpetuity cash inflows = cash flows per year /interest rate

= $6000/11%

= $54545.45

So it is better to choose alternative 2 as it results in $4545.45 ($54545.45 - $50000) more than alternative 1

ekkarill92 answered 2 years ago

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