Question

Justin Banks just won the lottery and is trying to decide between the annual cash flow payment option of $100,000 per year for 15 years beginning today, and the lump-sum option. Justin can earn 8 percent investing his money. At what lump-sum payment amount would he be indifferent between the two alternatives? Use the appropriate table located at the end of the textbook to solve this problem.

a) $824,424
b) $855,948
c) $890,378
d) $924,424

Answer 1

To determine the lump-sum payment amount that Justin Banks would be indifferent between the two alternatives, calculate the present value of the cash flow payments. The present value of the cash flow payments is approximately $824,424.

Step-by-step explanation:

To determine the lump-sum payment amount that Justin Banks would be indifferent between the two alternatives, we need to compare the present value of the cash flow payments to the lump-sum amount. The present value formula is:

PV = CF / (1 + r)^t

Where PV is the present value, CF is the cash flow payment, r is the interest rate, and t is the number of years. In this case, the cash flow payment is $100,000 per year for 15 years and the interest rate is 8%. Let's calculate the present value:

PV = $100,000 / (1 + 0.08)^1 + $100,000 / (1 + 0.08)^2 + ... + $100,000 / (1 + 0.08)^15

Using the appropriate table or a financial calculator, the present value of the cash flow payments is approximately $824,424. Therefore, the lump-sum payment amount that Justin Banks would be indifferent between the two alternatives is $824,424.