Question

After hearing a knock at your front door, you are surprised to see the Prize Patrol from a large, well-known magazine subscription company. It has arrived with the good news that you are the big winner, having won $34 million. You have three options. (a) Receive $1.7 million per year for the next 20 years. (b) Have $11.5 million today. (c) Have $3.25 million today and receive $1,400,000 for each of the next 20 years. Your financial adviser tells you that it is reasonable to expect to earn 14 percent on investments.

Answer 1

The requirement is to calculate the present value of each option:

$ 11.26 million

$11.5 million

$ 12.52 million

Step-by-step explanation:

The present value formula in excel is very useful in this case:

=-pv(rate,nper,pmt,fv)

rate is the 14% interest rate to be earned per year

nper is duration of the payment

pmt is the amount of payment expected per year

fv is the is the future worth of the payment which is unknown

Option 1:

=-pv(14%,20,1.7,0)=$ 11.26 million

Option 2:

The amount receivable today is the present value i.e $11.5 million

option 3:

=-pv(14%,20,1.4,0)=$9.27 million

total =amount received today+$ 9.27 million=$3.25 million+$ 9.27 millon=$ 12.52 million