Question

Suppose you won the Tri-State Megabucks Lottery in the previous question. What factors should you take into account in deciding whether you should take the annuity option or the lump-sum option?

Ross, Stephen. Essentials of Corporate Finance (p. 154). McGraw-Hill Higher Education. Kindle Edition.

Answer 1

Before deciding on the option to consider, it is important to consider the benefits and costs of the same.

The following factors need to be considered before finalizing the payment option.

a) Annuity amount :What amount will be paid regularly

b) Number of years : For how many years

c) Appropriate Discounting rate: It depends on the rate of return and the risk associated

The present value of the annuity and the lump sum amount should be found and compared before taking the final decision. If the present value of annuity plan is greater than the lump sum amount, the former plan should be opted and vice versa. The plans can only be compared if they are in the same time frame. SO we need to find their value on the present-day for making the comparison.