Question

John won the lottery. He can take annual payment that provides an implied 4% return per year for 45 years or he can take a lower cash amount now and put it in the bank. He wants it safe - in a savings account. What should he do? Also, if John takes it now, he has investment opportunity with a 10% return (and a 50% probability) - should he take the lump sum and invest or should he take the annual payment providing him with an implied 4% return?  

Answer 1

John should calculate the present value of all cash flows. So if the lower cash amount paid to John is higher or equal to the PV of the cash flows at a discount of 4%, then he should choose immediate payout. On the other hand if annuity payments present value are higher, then annuity should be chosen.

Similarly, the expected return of investment is 10%*0.5+0= 5%

So if the PV of the investment cash flows at 5% is higher than PV of annuity cash flows at 4%, then investment option should be chosen otherwise annuity