Calculating present value of an incentive
You have been offered a job with an unusual bonus structure. As long as you stay with the firm, you will get an extra $70,000 every seven years, starting seven years from now. What is the present value of this incentive if you plan to work for the company for a total of 42 years and the interest rate is 6% (EAR)
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Solution Preview
First for the formula for figuring this discount based upon the future payments:
Formula is NPV = Principal/(1+i) for 6 periods encompassing 42 years --- so we would apply it 6 times over the 42 year period.
In lieu of that, we can apply the present value table listing net present value factors for this period in time. Using this table we find that the factors for discounting are:
7 years @ 6% = .665
14 years @ 6% = .442
21 years @ 6% = .294
28 years @ 6% = .196
35 years @ 6% = .122
42 years @ 6% = .056
Now we simply ...
Solution Summary
Applying future bonus payments will result in applying the time value of money principle to these future payments, which results in discounting future flows of cash to the present in order to gain perspective on the true current value of these future cash flows.