QUESTION ON

(A) Alfred Banda, a legal practitioner, has just won lottery amounting to K2,000,000. There has been an agreement between the Lottery Company and Alfred regarding the way payments will be made. The two parties have agreed to an equal annual instalments of K500,000. The lottery is not paying him immediately. The first payment will be made at the end of the sixth year.

Assume that the opportunity cost of capital is 15%.

i.Find the future value of the payment.[5 Marks]

ii.Suppose that the alternative to receiving the money in instalments is to receive immediate cash amounting to K1,500,000. Which option would you advise Alfred to accept? Explain. [5 Marks]

(B)Suppose, instead, that Alfred has been told that he will receive his money in Twelve (12) equal monthly instalments with the first payment being made at the end of month 1. The lottery company has also assured Alfred of a 5% interest on the remaining balance.

i.Use an appropriate structure or computation to show the periodic payments and the associated interest. [20 Marks]

ii.How much will Alfred have received in total by the beginning of the 7^th Month?[3 Marks]

iii.Consider the amount you have found in (ii) above. What is the present value of that amount if the monthly interest rate is 12%? [4 Marks]

iv.Refer to (iii) above. Suppose that the alternative is to receive K1,400,000 today, then the remaining amount to be paid in equal instalments for a specified remaining period of part (ii) above . Which option is the best and why? [3 Marks]

C.Suppose that Alfred has analysed the situation in (A) and in (B). In his conclusion , he thinks the better way to receive his money is for the lottery company to pay him the money in 10 months and that the lottery company should be reducing the amount of the moneythey owe him by K200,000 per month. If a 5% interest is still considered, use an appropriate structure or computation to show the periodic payments and the associated interest.[10 Marks]