Question

While in Duke for immersion, you stop by a Circle K convenience store to get gas and a drink. While you’re at the counter you realize you have an extra $5 in your pocket, and decide to buy a North Carolina scratch-off lottery ticket. With your last penny, you scratch off the boxes -- and BAM! -- You win $1,000,000!! Whoop Whoop! After taking out 40% in federal and state taxes, the lottery commission offers you two choices:

1) 10 equal annual installments, with the first one starting today or

2) a lump sum of cash today

a)    If your cost of capital (required rate of return) is 5%, what’s the minimum lump sum you’d be willing to accept (i.e. an equivalent value between the two alternatives)?

b) List two (2) other considerations that might influence your decision about which alternative to take?

Answer 1

	1)	Present Value of Lump sum Cash	$600,000	(1million*(1-0.4)
	Rate	Required rate of return	5%
	Nper	Number of annual installments	10
	Pv	Present Value of after tax winning	$600,000
	Type	Payment at beginning of year	1
	PMT	Amount of Installment Payment	$74,003	(Using PMT function with Rate=5%,Nper=10,Pv=-600000,Type=1)
	a)	Minimum lump sum you’d be willing to accept	$74,003
	b)	Two (2) other considerations that might influence your decision
		1. Likelihood of change in interest rate
		2. Need for the cash now (Liquidity Preference)