P5–25 Value of an annuity versus a single amount Assume that you just won the state lottery.

Your prize can be taken either in the form of $40,000 at the end of each of the next 25 years (that is, $1,000,000 over 25 years) or as a single amount of $500,000 paid immediately.

a. If you expect to be able to earn 5% annually on your investments over the next 25 years, ignoring taxes and other considerations, which alternative should you take? Why?

b. Would your decision in part a change if you could earn 7% rather than 5% on your investments over the next 25 years? Why?

c. On a strictly economic basis, at approximately what earnings rate would you be indifferent between the two plans?