Q23E - Horngren'S Financial And Managerial Accounting

Question

Congratulations! You have won a state lottery. The state lottery offers you the following (after-tax) payout options:

Option #1: \(12,000,000 after five years Option #2: \)2,150,000 per year for five years Option #3: $10,000,000 after three years

 

Assuming you can earn 6% on your funds, which option would you prefer?

Step-by-Step Solution

Answer

Option #2 would be preferable.

Step 1: Meaning of Lottery

A lottery could be a kind of gaming in which members buy numbered tickets. The numbers on tickets are picked, and those with particular numbers on their tickets win a prize.

Step 2: Analyzing the various option

Option #1

$\begin{array}{rcl}Present value& =& Amount recceivable at the end of 5th year\times PVF@6\%, 5year\\ & =& \$12,000,000\times 0.747\\ & =& \$8,964,000\end{array}$

Option #2

$\begin{array}{rcl}Present value& =& Amount recceivable at the end of1st to 5th year\times PVF@6\%,5year\\ & =& \$2,150,000\times 4.212\\ & =& \$9,055,800\end{array}$

Option #3

$\begin{array}{rcl}Present value& =& Amount receivable at the end of 3rd year\times PVF@6\%,3year\\ & =& \$10,000,000\times 0.840\\ & =& \$8,400,000\end{array}$

Option #2 depicts more present value as compared to the other option. So, option #2 will be preferable.