Despite your better judgment you bought a lottery ticket you won! You now need to decide...

Despite your better judgment you bought a lottery ticket you won! You now need to decide which payout option to take: a) an immediate lump sum of $130,000; b) $1,000 per month to be received at the end of this month and every month thereafter for 40 years in total; or, c) $10,000 to be received one year from now and every year thereafter for 50 years in total.

Assuming an annual discount rate of 9%, which payout option should you take based on a comparison of the present value of each of the 3 payout options (i.e., please note the present value of each alternative and which one you would select)?

Solutions

Expert Solution

a.Present value of the lump sum is $130,000

b.Information provided:

Monthly payment= $1,000

Time= 40 years*12= 480 months

Interest rate= 9%/12= 0.75% per month

The present value is calculated by entering the below in a financial calculator:

PMT= 1,000

N= 480

I/Y= 0.75

Press the CPT key and PV to compute the present value.

The value obtained is 129,640.90.

Therefore, the present value of the second option is $129,640.90.

c. Information provided:

Monthly payment= $10,000

Time= 50 years

Interest rate= 9%

The present value is calculated by entering the below in a financial calculator:

PMT= 1,000

N= 480

I/Y= 0.75

Press the CPT key and PV to compute the present value.

The value obtained is 109,616.83.

Therefore, the present value of the third option is $109,616.83.

I should choose the lump sum payment of $130,000 since it has the highest present value.

In case of any query, kindly comment on the solution

jeff jeffy answered 2 weeks ago

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