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.)
The PV of X = $1,000,000; The PV of Y = $1,371,000; The FV of X = $1,276,000; The FV of Y = $1,500,000. Based on both present values and future values, B is the better choice. Finding present values and future values are simply reverse processes of one another, and that choosing between two lump sums based on PV will always give the same result as choosing between the same two lump sums based on FV.
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