Question

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 $2,900 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. At an interest rate of 5% per year, the winner would be better off accepting thelump sum , since that choice has the greater present value. At an interest rate of 9% 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

Answer:

 It will depend on the interest rate; advise her to get a calculator. 

Explanation:

The present value of the cash flows at a 5% and 9% discount rate are $2,859.41 and $2,759.11 respectively. The lump sum of $2900 is better because it is higher than the present values of the cash flows.

The decision to accept either the lump sum or the cash flows should depend on the interest rate.

If the present value of the cash flows discounted at the interest rate is greater than the lump sum, the cash flows should be accepted. If it isn't, the lump sum should be chosen.

I hope my answer helps you