Question

Lottery A pays $1,000 today and Lottery B pays $1,750 at the end of five years...

Lottery A pays $1,000 today and Lottery B pays $1,750 at the end of five years from now. If the discount rate is 5%, I should choose

Lottery A, because it is available to me now.

Lottery A, because its future value is $1,276.

Lottery B, because its present value is $1,371 which is more than that of Lottery A.

Lottery B, because it pays $1,750 which is more than $1,000 from Lottery A.

Either option gives the same value over time.
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Homework Answers

Answer #1

The question is solved by comparing the presewnt values of both the options.

The present value of lottery B is calculated first to solve the question.

Information provided:

Future value= $1,750

Time= 5 years

Yield to maturity= 5%

Enter the below in a financial calculator to compute the present value:

FV= 1,750

I/Y= 5

N= 5

Press the CPT key and PV to compute the present value.

The value obtained is 1,371.17.

Therefore, the present value of lottery B is $1,371.17.

Hence, I should choose lottery B since its present value is higher than lottery A.

The answer is option c.

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