Question

Attempts: Average: 3 3. Which lottery payout scheme is better? Suppose you win a small lottery and have the choice of two ways to be paid: You can accept the money in a lump sum or in a series of payments over time. If you pick the lump sum, you get $2,750 today. If you pick payments over time, you get three payments: $1,000 today, $1,000 1 year from today, and $1,000 2 years from today. since that choice has the greater present At an interest rate of 6% per year, the winner would be better off accepting the value. At an interest rate of 10% per year, the winner would be better off accepting since it has the greater present value. Years after you win the lottery, a friend in another country calls to ask your advice. By wild coincidence, she has just won another lottery with the same payout schemes. She must make a quick decision about whether to collect her money under the lump sum or the payments over time. What is the best advice to give your friend? The lump sum is always better, The payments over time are always better. It will depend on the interest rate; advise her to get a calculator. None of these answers is good advice.

Answer 1

Solution:-

(a) At i = 6%

PV of payments over time = 1,000 + 1,000 x P/A (6%, 2)

                                          = 1,000 + 1,000 x 1.8334

                                          = 1,000 + 1,833.4

                                          = 2,833.4

Winner is better off accepting payments over time since its PV is higher than lump-sum.

(b) At i = 10%

PV of payments over time = 1,000 + 1,000 x P/A (10%, 2)

                                          = 1,000 + 1,000 x 1.7355

                                          = 1,000 + 1,735.5

                                          = 2,735.5

Winner is better off accepting lump-sum since its PV is higher than payments over time.

(C). it will depend on the interest rate, advise her to get a calculator. Present value of future payments depends on interest rate.