Question

1. You just won $1 million dollars in the lottery! They offer you two options for your winnings: a lump sum payment right now, or $100,000 a year over the next 10 years. Current 10-year interest rates are at 5%, and the current tax on lottery winnings is 40%.  
   • What is the amount you will receive today with the lump sum option?
   • Which option would you select? How would you present your argument for your decision in a debate?
2. Sorry, you didn’t win the lottery, but here’s a way you can still be a millionaire! Starting at age 22, every night you take $5 out of your pocket and put it in a manila envelope (title it “Lottery Winnings”). At the end of the year, you place the money from the envelope in a stock fund with an average interest rate of 10%.
   • How much will you have in the account when you retire at age 65?
   • What would be different if you started this plan later in your life?

Answer 1

Amount Received in lump sum option:- $ 1 million * (1-0.40) = $ 0.60 million

Which Option would be slected:- Option of lump sum payment, Why? Because i have to pay 40% tax whether i get lottery in lump sum or in installments. since interest rate is 5%, if i get lump sum amount today i will invest at 5% at get passive income. But in installment i will get this amount in parts and my future income will be less than option of ump sum.

How much i have account at age of 65:- Deposit amount = 5*365 = $ 1825, interest rate = 10%, age at time of deposit = 23, Years = 65-23 = 42, So future value of 1825 deposit every year :- $ 1825 + 1825*FVAF(10%,42) = 1825 + 1825*591.40 = $ 10,81,130/-

If i plan later in life:- then in such case there will be lesser amount in my retirement fund.