Anna Waldheim was seriously injured in an industrial accident. She sued the responsible parties and was awarded a judgment of $2,000,000. Today, she and her attorney are attending a settlement conference with the defendants. The defendants have made an initial offer of $156,000 per year for 25 years. Anna plans to counteroffer at $255,000 per year for 25 years. Both the offer and the counteroffer have a present value of $2,000,000, the amount of the judgment. Both assume payments at the end of each year.
What interest rate assumption have the defendants used in their offer (rounded to the nearest whole percent)?
What interest rate assumption have Anna and her lawyer used in their counteroffer (rounded to the nearest whole percent)?
Anna is willing to settle for an annuity that carries an interest rate assumption of 9%. What annual payment would be acceptable to her?
Given the details of an offer and a counteroffer, this solution illustrates how to determine the interest rate inherent in each and the payment inherent in a third alternative.