Question

You have just won the lottery! You decide to take your winnings as a series of $1,000,000 payments for the next 20 years with the first payment being paid today. What method should we use to value the series of payments?

Select one:

a. Ordinary Annuity

b. Ordinary Perpetuity

c. Compounding Annuity

d. Annuity Due

e. None of these describes how the series of payments should be valued.

Answer 1

Annuity Due is an Annuity whose payment is due immediately at the beginning of each period.

Since the first payment is made today, so the payments start at thebegining of the period.To evaluate the series of payments , Annuity due is the best method. Hence option d) is correct.

Explaining why the other answers are not correct.

a) An ordinary Annuity is a series of equal payments made at the end of consecutive periods over a fixed length of time. Since we receive first payment today but not at the end of first period, so ordinary Annuity is not applicable.so option a) is not the correct answer.

b)Ordinary perpetuity : Perpetuity means payment continues forever, there is no time period. In the question it is stated fixed period of time i.e 20 years so Ordinary Annuity technique not applicable.So option b) is not the correct answer.

c)Compounding Annuity : . Compounding annuity is nothing but finding out the future value.We need to evaluate the present value of payments.so this technique not applicable here.

e) Noneof these: Since our answer is already d) so option e is not the correct answers.