Question

James just won the lottery for $30 million! He has two choices: first, he may receive $15 million today, or he may receive equal payments of $1 million a year for the next 30 years. Currently, the discount rate that he could invest the $15 million is 7% compounded annually. What should James do?

Answer 1

The best option is the first one. It provides a higher present value.

Explanation:

Giving the following information:

Option 1:

Receive $15,000,000 today.

Option 2:

Receive $1,000,000 for 30 years.

Discount rate= 7% compounded annually

To compare both options, we need to calculate the present value of Option 2. The option with the higher present value is the most convenient.

Option 2:

First, we need to determine future value:

FV= {A*[(1+i)^n-1]}/i

A= annual cash flow

FV= {1,000,000*[(1.07^30) - 1]} / 0.07

FV= $94,460,786.32

Now, the present value:

PV= FV/(1+i)^n

PV= 94,460,786.32 / (1.07^30)

PV= $12,409,041.18

The best option is the first one. It provides a higher present value.