|
Financial Challenges
Chapter 4
Powerball Opportunity
Unlike major Canadian lotteries that pay only lump-sum prizes, the multistate Powerball Lottery in the United States gives its winners a choice. During the summer of 2001 the Powerball jackpot reached US$294.8 million. Many Canadians live close enough to the border that they could participate in this lottery and many of them crossed the border to buy tickets. Unfortunately, none of them won. For this particular draw, four winning tickets were sold, with each winning ticket entitled to one-fourth of the total jackpot, or $73.7 million. Each of the four winners had two choices concerning payment of the prize:
- Receive an immediate lump-sum payment of $41.4 million.
- Receive $73.7 million paid out over 25 years—that is, $2.948 million at the beginning of each year for the next 25 years.
Suppose you are a financial advisor to one of the winning ticket holders. How should the ticket holder go about choosing between the two alternatives? Obviously, the rate of return your client could expect to earn from investments is an important variable in making an informed decision.
Many decisions that managers encounter involve streams of cash flows that are paid out over time. To make informed decisions, a manager needs a working knowledge of the time value of money—the topic of this chapter. Later in the chapter, we provide a solution to the decision of whether to take the lump-sum payment or the 25 annual payments. (Note: Although lottery winnings are tax-free in Canada, they are taxable in the United States. So, if a Canadian won, this winner would have to pay income taxes on the lottery prize to the United States on this US source income. Nevertheless, we will ignore taxes in the analysis.)
Back to Financial Challenges
|
|
