Question

Suppose you win the lottery when the jackpot amount is $162 million. You can receive the jackpot amount paid out evenly over 26 years or you can elect to take an immediate payment of $95 million, before taxes. Ignore all tax effects. Considering this scenario, which option is most advantageous and why? (Be specific as to any calculations performed.) What other factors should be considered in making your decision?

Important Note: Please be sure your response is based on our course concepts: the time value of money. Your post should include calculations for both payout options using the time value of money, explain your assumptions, and interpret the results of your calculations. You may also discuss any and all other factors that will impact the decision as to which type of payout option you would choose but only after you have completed the calculations necessary to support your response.

Answer 1

In order to consider this situation the most obvious thing is the time value of money. There is two options only.

1. To receive $162 million in 26 yearly installments making a $6.23 million yearly payment
2. To receive $95 million outright

Let’s take a discount rate for annuity purpose to be 5%. Now we have to convert these two options to bring them at their respective present values. PV factor @5% for 26 years comes to: 14.375

Option I. $6.23 million x 14.375 = $89.56 million (approx.)

Option II. $95 million x 1.00 = $95 million

After comparing these two options, it would be advisable to take option II because it fetches more present values today rather getting annuities for over 26 years.

A capital budgeting decision depresses reported income for the current period but has the potential to generate high cash inflows in the future. The concept of the time value of money is basic to capital budgeting. The time value of money implies that:

A dollar is worth more today than a dollar received tomorrow because that dollar can be invested today or earn a return.

A dollar tomorrow is worth less than a dollar today because of the interest foregone.