Question

You have just won the $1,000,000 in the lottery. You have the option of taking a lump sum payout or equal annualized payments over 20 years. Ignoring any tax consequences; how much should you expect from the annualized payments. What target interest rate would make the annualized payments more valuable than the lump sum. In your response, you may want to consider such issues as inflation, investing lump sum in stock market (What have been the long-term historic returns?) to generate your own annualized payment schedule, as well as the psychological components – receiving a $1,000,000 check.

Answer 1

Suppose, Stock Market average historic return is Rm and Inflation rate is I

So, to calculate the annualized payment schedule the discount rate that need to be used is =(Rm+I)

Now, if the interest rate is greater than (Rm+I) then the Present value of all future cash flow would be less than the $1000000 but if the interest rate is less than (Rm+I) then the Present value of all future cash flow would be greater than the $1000000 and the annualized payment would be more attractive.

If you get a $1000000 check at once you may psychologically so excited that you may expense much portion of the cash. Or, you can start a new business using this money as the investment capital but it involves risk.

So, to play it safe you can choose to get annualized payment.