Week 3 Discussion
Personal financial decisions, like whether to accept a lump sum of money today or receive money in the future, are also guided by the time value of money concept. In this week’s discussion we will explore and examine the time value of money factors and other considerations that influence a lottery winner’s decision on whether to accept a lump sum payment today or receive annuity payments over time.
Scenario: Have you noticed that when someone wins the lottery they are given two payment options? They are asked if they want a “lump sum” payment immediately, or if they are willing to have their payments staggered over time and receive a larger sum of money. If they choose the latter option, the payments are split into annual annuity payments for an extended period of time (typically over a 30-year period).
Here is an example of an actual $398 million Powerball lottery winner. The winner was given the choice of receiving a $213 million lump-sum payment immediately, or receiving $398 million in payments spread out over the course of 30 years. If the winner chose the option of receiving annual payments, the winner would receive larger payments each successive year. The winner would receive $7.1 million in year one, $7.4 million in year two, and so on. The amounts would increase each year and would culminate in a final payment of $22 million in year 30.
Discuss all of the following questions:
- Which payment choice would you make? Why?
- Why do you think the Powerball Lottery organization offers these two different payment options to the winner? What do you think are the pros and cons of each option for the Powerball Lottery organization? What do you think are the pros and cons of each option for the winner?
- Explain how the time value of money is used in the decision making of the lottery winner.
- Explain how the lottery officials use the time value of money in designing the payment options offered to winners.
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