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I evaluated the three options Sally Hamilton has to choose from and this is what I came up with: (Although I think my calculations are correct, please feel free to critique and correct my errors!)

Option 1 gives Sally a $50,000 cash bonus paid now. I chose to evaluate this amount to see what the future value would be in 6 years, since the other options are based on 6 years. The future value at 6 years and earning 6% came to $70,926.

Option 2 is an annuity due, with the first $10,000 paid now, and another $10,000 paid each year over the next 6 years. I used the FVAD chart, with 6 periods at 6% and the future value came to $73,938. Based on these numbers, the Present Value of option 2 is $52,123.

Option 3 is a deferred annuity. To calculate the annuity, I used the FVA chart for 3 periods at 6% x $22,000 which gave me a total future value of $70,039. For the present value I used the $70.039 total, used the Present Value chart for 2 periods at 6% and got a Present value of $62,335.

Based on my calculations, it would be more profitable for Sally Hamilton to chose option 2 as her return on her investment would be greater than if she chose either other option. Although the present value is greater for option 3 than the others, I don't think Sally should look too much at this number because the only real present value she should go by is option 1 which would give her the entire bonus immediately. But based on the calculations, Sally would earn more choosing option 2 than the other options and therefore should go with that option.

The questions I'm still a little confused about, and which would make a difference in my calculations are this: For option 2, because it is an annuity due and the payments are made at the beginning of the period, should my number of periods actually be 5 instead of 6? And for option 3, because it is an ordinary annuity the first payment is made at the end of the third period, when I drew this out on a number line it appeared to me that I should use 2 periods instead of three to obtain the present value of the deferred annuity. Is this correct, or should I have used 3 periods when calculating the present value?

Thanks everyone for your help in figuring this out!

Discussion: Bonus Alternatives and Present Value Analysis

Evaluate the three alternative bonus plans, posting your questions and insights for the class.

Sally Hamilton has performed well as chief financial officer of the Maxtech Computer Company

and has earned a bonus. She has a choice among the followig three bonus plans:

1. A $50,000 cash bonus paid now.

2. A $10,000 annual cash bonus to be paid each year over the next six years, with the first $10,000

paid now.

3. A three-year $22,000 annual cah bonus with the first payment due three years from now.

Sally can earn a 6% annual return on her investments.

Discussion: Bonus Alternatives and Present Value Analysis

Sally Hamilton has performed well as chief financial officer of the Maxtech Computer Company and has earned a bonus. She has a choice among the followig three bonus plans:

1. A $50,000 cash bonus paid now.

2. A $10,000 annual cash bonus to be paid each year over the next six years, with the first $10,000 paid now.

3. A three-year $22,000 annual cah bonus with the first payment due three years from now.

Sally can earn a 6% annual return on her investments.