Question

Congratulations!!!!!! You just won a lottery. It will pay you $1,000,000 ten years from today. You were watching TV late last night and heard an ad for one of those companies willing to buy your lottery prize in ten years for an immediate single cash payment: a. What is the least you would sell the claim for if you can earn 6% on an investment of comparable risk? b. If 6 percent is the appropriate interest rate and the settlement company give you the choice of the $1 million in 10 years or $80,000 a year for the next 10 years, with the first receipt in one year. Why (show calculations)?

Answer 1

HI

a) Here Future Value F = $1,000,000

time t = 10 years

rate r = 6%

a) Current Claim P=?

P = F/(1+r)^t

P = 1000000/(1+6%)^10

= 1,000,000/1.06^10

=$558,394.78

hence you should atleast claim $558,394.78 today.

b) interest rate r= 6%

Future Value F= 1,000,000

Annual amount C= $80,000

time t = 10 years

F = (C/r)*((1+r)^t-1)

1,000,000 = (C/0.06)*(1.06^10-1)

C = 60000/0.79

=$75,8567.96

So calculated payment amount is almost similar to $80,000 payment. That;s why settlement company giving you the amount.

Thanks