In our class example, I simplified the “annuity” prize option byassuming level, equal annual payments. Actually, this annuity prizeoption us now on an annuitized prize payment schedule with 30beginning of year payments that start at a lower amount with eachsuccessive payment being 5% higher than the previous annualpayment. The sum of these 30 annuitized payments equal theannounced estimated jackpot amount with a lower one-time lump-sumpayment also being available as the Cash Option.

A recent Mega Millions estimated jackpot amount is $300 millionwhich is the undiscounted sum of the 26 annuity option paymentswith a Cash Option of $207 million. The first payment under theAnnuity Option which would occur immediately is $4,515,432 with 29additional annual payments with each payment being 5% larger thanthe previous one. Using this information and assuming you demand a4% annual return, would you prefer the Annuity Option or the CashOption if you have the winning ticket?

Please include the following to support your decision:

1. A complete schedule of all 30 annual payments under theAnnuity Option. (Please use excel)

2. A comparison of the present value of all the payments underthe Annuity Option and the present value of the Cash Option.

3. Use the Excel IRR function to find the interest rate thatequates the PV of the annual payments with the cash option. This isthe rate of return that the annuity option pays. Hint: you willhave to deduct the first annual payment from the cash option amountfor the initial (time zero) cash flow to calculate this rate.

4. Your decision.