3. Which lottery payout scheme is better? Suppose you win a small lottery and ha

Question

3. Which lottery payout scheme is better? 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 (Payout Scheme X) or in a series of payments over time (Payout Scheme Y). If you pick Payout Scheme X, you get $2,750 today. If you pick Payout Scheme Y, you get three payments: $1,000 today, $1,000 one year from today, and $1,000 two years from today. , since it has the At an interest rate of 10% per year, the winner would be better off accepting Payout Scheme greater present value. At an interest rate of 8% per year, the winner would be better off accepting Payout Scheme greater present value. , since it has the 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 Payout Scheme X or Payout Scheme Y. What is the best advice to give your friend? O Payout Scheme X is always better. O Payout Scheme Y is always better. O It will depend on the interest rate; advise her to get a calculator. O None of these answers is good advice.

Explanation / Answer

Scheme X = $2750

Scheme Y (PV) = 1000 + 1000/1.1 + 1000/1.12 = $2735.54

At an interest rate of 10% per year, the winner would be better off accepting payout scheme X , since it has the greater present value.

Scheme Y (PV) = 1000 + 1000/1.08 + 1000/1.082 = $2783.26

At an interest rate of 8% per year, the winner would be better off accepting payout scheme Y , since it has the greater present value.

Correct option:

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

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