After hearing a knock at your front door, you are surprised to see the Prize Pat

Question

After hearing a knock at your front door, you are surprised to see the Prize Patrol from a large, well-known magazine subscription company. It has arrived with the good news that you are the big winner, having won $35 million. You have three options. Receive $1.75 million per year for the next 20 years. Have $11.75 million today. Have $3.5 million today and receive $1,450,000 for each of the next 20 years. Your financial adviser tells you that it is reasonable to expect to earn 12 percent on investments. Requirement: Calculate the present value of each option. (Future Value of $1. Present Value of $1. Future Value Annuity of $1. Present Value Annuity of $1.) (Use appropriate factor(s) from the tables provided. Enter your answers in dollars but not in millions.) Determine which option you prefer

Explanation / Answer

Calculation of present value:

Option A:

P = PMT [(1 - (1 / (1 + r)n)) / r]

Where:

P = The present value of the annuity stream to be paid in the future

PMT = The amount of each annuity payment

r = The interest rate

n = The number of periods over which payments are to be made

PV = 17500000 [1- 1 / (1+.12)^20] / .12 = $13,07,15,263.43

Option B : Present Value = $11750000

Option C:

PV = 3500000 + 1450000 * [1- 1/(1+.12)^20] / .12 = $11,18,06,932.55

2. Option A is most preferred

Present Value Option A $13,07,15,263.43 Option B $11,75,00,000 Option C $11,18,06,932.55

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