Question

Suppose you have just won a $5 million lottery today. When you win the lottery, you generally receive payments of the lottery jackpot over twenty years. Therefore, your $5 million lottery winnings consist of twenty annual payments of $250,000 each. But wait! Don’t forget about the taxes. The IRS will take 25 percent of each check, so you are left with $187,500 each year. Assume that the annual interest rate is 3%.

So, if someone offered you a lump-sum of $2 million for your lottery winnings today, would you take it? Please explain how would you answer this question?

Answer 1

Calculate the present value of future cash flows from the lottery i.e.

According to the question language, the lottery will be received at time 1 and continue for till time 20 in years. This will ensure 20 years time period.

Present Value of Annuity = (1-(1+Rate)^time)/Rate

B4 fx =PV(B2,B3,-B1,0) B С D 187500 A 1 Annuity 2 Interest Rate 3 Time 4 Present Value 3% 20 $2,789,526.54 5

Now you should not accept lump sum payment of $2million as you will get more that $2milllion with an interest rate of 3%.