Question

Time Value of Money

COLLAPSE

You have just won the $1,000,000 in the lottery. You have the option of taking a lump sum payout or equal annualized payments over 20 years. Ignoring any tax consequences; how much should you expect from the annualized payments. What target interest rate would make the annualized payments more valuable than the lump sum. In your response, you may want to consider such issues as inflation, investing lump sum in stock market (What have been the long-term historic returns?) to generate your own annualized payment schedule, as well as the psychological components – receiving a $1,000,000 check.

Answer 1

It is difficult to choose the lump sum payment or annularised payment. But if we choose lumpsum payment rather than annualized payment over 20 years, you will recieve much lower than amount as compare to lottery jackpot($1,000,000).

If you owe the lumpsum amount it will attract taxability of the same income in which this income is received. It will be consider in upper tax bracket i.e. 30%+3% slab rate which come to directly loss of individual in lump sum payment is ($1,000,000 * 30.9%) i.e. $30900 which includes education cess 3%.

If you want to recieve the Annualized payment rather than lumpsum in 20 years than you can take present value cash for the lottery part and buys or invest the same in share market( Bonds, Debentures and equity) which gives interest to funds for future payment.

If you got and want lump sum amount and want to match your portfolio like annualised amount over 20 years then yoe would like to invest the same lumpsum amount as a better way that gives significantly higher return on investment that you need to get the same.

So it is better for to choose Annualised return for getting higher return over 20 years than recieving lumpsum amount in one time.