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Future and Present Value of cash flows

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Congratulations! You have just won the lottery!

However, the lottery bureau has just informed you that you can take your winnings in one of two ways. Choice X pays $1,000,000. Choice Y pays $1,750,000 at the end of five years from now.

Using a discount rate of 5 percent, based on present values, which would you choose?
Using the same discount rate of 5 percent, based on future values, which would you choose?
What do your results suggest as a general rule for approaching such problems?
(Make your choices based purely on the time value of money.)

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Solution Summary

The solution describes the steps in evaluating the given options by comparing present and future values of cash flows.

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Solution :

Present Value Method
Present Value of Option X = $1,000,000
Now calculate Present Value of Option Y
We know PV of any future value at given discount rate r in n periods is given by
PV=FV/(1+r/100)^n
PV = $1750000/(1+5/100)^5 =$1371171
Present ...

Solution provided by:
Lokesh Jain, MSc
Education
  • BEng (Hons) , Birla Institute of Technology and Science, India
  • MSc (Hons) , Birla Institute of Technology and Science, India
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