Question
2. Congratulations! You have just won the Connecticut state lottery. You can elect to receive your prize in one of four payment streams: (i) $1,500,000
2. Congratulations! You have just won the Connecticut state lottery. You can elect to receive your prize in one of four payment streams:
(i) $1,500,000 on Nov. 6th of 2027 (10 years from now)
(ii) $40,000 per year in perpetuity, with payments made at Nov. 6th of each year and the first payment comes one year from today.
(iii) $120,000 per year for the next ten years, with payments made at Nov. 6th of each year and the first payment comes one year from today.
a. If the annual interest rate is 4% and assumed fixed at that level, calculate the present value of each of the four payment options. Find the PV of each option and rank the four options from most valuable to least valuable.
b. Now you believe that there will be a mild inflation of 2% annual price level increase. You believe that nominal interest rate will be adjusted so that the real interest rate stays the same 4%. Find the PV of each option again and rank the four options from most valuable to least valuable.
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