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Decision-making using Net present value analysis.

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Sandy Rose was given two options for receiving her winnings, if she won, from the Reader's Digest sweepstakes. Option A is a payment of $1 million immediately, plus $137,932 per year for the next 29 years. Option B is an immediate payment of $167,000, plus additional payments of $167,000 per year for the next 29 years. Which option should she choose and why? (assume no taxes).

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Solution Summary

The problem deals with ascertaining the best option, out of two options. The options involve accepting an immediate cashflow or accepting equal payments made in the future.

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The solution, presented in the Word attachment, contains the guidelines and techniques for analyzing problems involving decision making.

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In deciding which option to choose, it is pertinent to look at which of the options has a higher present value.
A higher present value is beneficial for her. Notwithstanding, the value of the discount rate the present value of Option A will always be higher than that of Option B.

The present value, for the problem, can be estimated by

Where,
CF1 = the cashflow in year 1. (Option A = 1,000,000 and Option B = 167,000)
R = the selected discount rate
PVOA = present value of ordinary annuity, from time 2 - 29.

A B C D E F G
(1 + D)^A B/E C/E
DISCOUNTED CASHFLOW
YEAR Option A Option B DISCOUNT RATE DISCOUNT FACTOR ...

Solution provided by:
Chidi Ngene, M. Sc.
Education
  • B. Sc., University of Nigeria
  • M. Sc., London South Bank University
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