Bob's Lottery Inc. has decided to offer winners a choice of $195,000 in 10 years or some amount currently. Assume that Bob's Lottery Inc. earns a 7 percent after-tax rate of return. What amount should Bob's offer lottery winners currently, in order to be indifferent between the two choices? Use Exhibit 3.1.

The present value of 195,000 discounted by 7% over 10 years is 99,128 so in order to be indifferent between the 2 choices the would have to pay $99,128 today.

Explanation:

We need to find what amount of money today is equal to 195,000 10 years from now. For that we need to have an interest rate to discount 195,000 by which is given to us and is 7%. So we will have to discount 195,000 by 7% over 10 years.

195,000 / (1.07) ^10=99,128

The present value of 195,000 discounted by 7% over 10 years is 99,128 so in order to be indifferent between the 2 choices the would have to pay $99,128 today.