After hearing a knock at your front door, you are surprised to see the Prize Pat

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 $26 million. You have three options. (a) Receive $1.3 million per year for the next 20 years. (b) Have $9.5 million today. (c) Have $3.5 million today and receive $1,000,000 for each of the next 20 years. Your financial adviser tells you that it is reasonable to expect to earn 12 percent on investments. Required: 1. Calculate the present value of each option. (Future Value of $1, Present Value of $1, Future Value Annuity of $1, Present Value Annuity of $1.) (Use appropriate factor(s) from the tables provided. Enter your answers in dollars, not in millions.) Present Value Option A Option B Option C

Explanation / Answer

Solution:

Option A: Receive $1.3 million per year for the next 20 years:

Present value of option A = $1,300,000 * Cumulative PV factor at 12% for 20 periods

= $1,300,000 * 7.469444

= $9,710,277

Option B: Have $9.5 million today

Present value of option B = $9,500,000

Option C:Have $3.5 million today and receive $1,000,000 for each of the next 20 years

Present value of option C = $3,500,000 + $1,000,000 * Cumulative PV factor at 12% for 20 periods

= $3,500,000 + $1,000,000 * 7.469444 = $10,969,444

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