Question

A lottery winner can take $6 million now or be paid $600,000 at the end of each of the next 16 years. The winner calculates the internal rate of return (IRR) of taking the money at the end of each year and, estimating that the discount rate across this period will be 4%, decides to take the money at the end of each year. Was her decision correct?A) Yes, because it agrees with the payback rule.B) Yes, because it agrees with the Net Present Value rule.C) Yes, because it disagrees with the Net Present Value rule.D) Yes, because it agrees with both the Net Present Value rule and the payback rule.

Answer 1

Answer:

B) Yes, because it agrees with the Net Present Value rule

Explanation:

The Net present value is the present value of after tax cash flows from an investment minus the amount invested.

If the amount is positive, the project is desirable and if it is negative, it is not desirable.

The net present value can be calculated using a financial calculator.

Cash flow for year 0 = $-6,000,000

Cash flow each year from year 1 to 16 =$600,000

I = 6%

NPV = $991,377.365

The present value of $600,000 for 16 years is greater than the value of $6,000,000 now. Therefore, it is more profitable to take $600,000 every year for 16 years.

The payback period isn't useful here because it is used to calculate the amount of time it takes to recoup the amount from an investment.

I hope my answer helps you.