Problem 2 Comparing Options Using Present Value Concepts

After hearing a knock at your front door, you are surprised to see the Prize Patrol from a large, well-known magazine subscription company. It has arrived with the good news that you are the big winner, having won $12.5 million.

You discover that you have three options:

(1) you can receive $1.25 million per year for the next 10 years,

(2) you can have $10 million today, or

(3) you can have $4 million today and receive $1 million for each of the next eight years.

Your lawyer tells you that it is reasonable to expect to earn 10 percent on investments.

a) What is the present value of the above options?

b) Which option do you prefer?