Question

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.8 John’s sister, Sara, 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.” 

 

Required: 

Construct the text of an e-mail to Sara describing how the amount of the lump-sum settlement was determined. Include a calculation that might help Sara and John understand.

Answer 1

Calculation of accident settlement:

[(1 ÷ (1+0.07)1)]+ [1 ÷ (1+0.07)2] +. . . . . . . [1 ÷ (1+0.07)25]

 

Present value of an annuity:

Year	Cash flows ($)	Present value of an annuity of $ 1, i = @7%	PV of cash flows ($)
1 through 25 years	200,000	11.654	2,330,800

Calculation of accident settlement:

[(1 ÷ (1+0.07)1)]+ [1 ÷ (1+0.07)2] +. . . . . . . [1 ÷ (1+0.07)25]