Question

Alex Meir recently won a lottery and has the option of receiving one of the following three
prizes:

$64,000 cash immediately, (2) $20,000 cash immediately and a six-period annuity of $8,000
beginning one year from today, or (3) a six-period annuity of $13,000 beginning one year from
today. Assuming an interest rate of 6%, which option should Alex choose?

Answer 1

a.Present value of inflows=64000

b.Present value of annuity=Annuity[1-(1+interest rate)^-time period]/rate

=8000[1-(1.06)^-6]/0.06

=8000*4.91732433

=$39338.59(Approx)

Present value of inflows=cash inflow*Present value of discounting factor(rate%,time period)

=20,000+39338.59

=$59338.59(Approx)

c.Present value of annuity=Annuity[1-(1+interest rate)^-time period]/rate

=13000[1-(1.06)^-6]/0.06

=13000*4.91732433

=$63925.22(Approx)

Hence the option of 64,000 cash immediately is better having highest present value.