Dave Cooke hits the $160,000 jackpot at the Palms Casino in Las Vegas. The casino gives...
Dave Cooke hits the $160,000 jackpot at the Palms Casino in Las Vegas. The casino gives him two options for collecting his winnings:
| Option
A: |
Cooke can take all of his winnings today. They will be taxed by the federal government at 20%. |
| Option
B: |
Cooke can receive his winnings on an installment plan. He would receive 2020 equal payments of $10,000 beginning today. Each payment will be taxed at a rate of 10%. |
(Assume that taxes are taken out at the time of payment under both options.)
Requirement: Given an interest rate of 11%, compounded annually, which option should Cooke choose?
Begin by computing the present value of option A.
|
The present value of Option A is $ |
???? |
Now compute the present value of option B.
|
The present value of Option B is $ |
???? |
Cooke should choose ______.
A. Option A
B. Option B
Homework Answers
Present Value of Option A = Amount Received * (1- Tax rate) = $160,000*80% = $128,000
Option B
PMT = Amount Received * (1- Tax rate) = 10000*90% = $9000
Int Rate (r) = 11%
Time Period (n) = 20 years
Present Value of Option B = PMT * ((1+r)^n -1)/r = 9000 *( (1.11)^20 -1).11 = $ 577,825.49
Hence, Cooke should choose Option B.
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