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 or in a series of payments over time. If you pick the lump sum, you get $2,750 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 6% per year, the winner would be better off accepting the ? , since that choice has the greater present value. At an interest rate of 10% 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.

Explanation / Answer

Ans 1)

When interest rate is 6% Present worth of 2nd option is =1000+1000/1.06+1000/1.06^2=$2833.39

hence Preseent worth of 2nd option is greater than 1st option

When interest rate is 10% Present Worth of 2nd option =1000+1000/1.1+1000/1.1^2=$2735.53

Present Worth for potion 1 is higher than in 2nd option hence choose 1st option

Ans 3)

It will surely depends upon the interest rate as we saw in above example

Hence option 3 is correct answer

Related Questions

Navigate

• Browse (All)
• Browse 3
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.