As a new employee in the Lottery Commission, your first job is to design a new p

Question

As a new employee in the Lottery Commission, your first job is to design a new prize. Your idea is to create two grand prize choices: (1) receiving the lump sum of $1 million at the end of year 5, or (2) receiving $500,000 today followed by a lump sum amount at the end of year five. Using an interest rate of 8%, which of the following comes closest to the amount prize (2) needs to pay at the end of year five in order for both prizes to have the same present value? a. $500,000 b. $680,580 c. $1,000,000 d. $265,336 e. $333,333

Explanation / Answer

let amount paid at the end of year 5 = X

Present value of plan 1 = Present value of plan 2

$1,000,000/1.08^5 = $500,000 + X/1.08^5

X = $265,336

Correct option is (D)

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