I see that the Mega Millions Lottery is offering (a) $359 million now or (b) $19.2 a year for 26 years. The gross value of the payment stream is of course 19.2x26=$499.2 million. Hey, do the math and you'll see that $499.2 tops $359 so take the deferred payments, right?
Well, I gather that's that what the grownups want us to think. Don't take it now or you'll blow it. Take the payments, you'll do better in the long run.
But of course it's not right. Time is money and the present value
of the payment stream is the nominal value discounted at the
appropriate interest rate.
Anyway, try this. Assume you get your first payment today
and subsequent payments at the beginning of each of 25 more years. So
if you take the payments you are "paying" $339.8 ($359-$19.2) million.
What is the implied discount rate (internal
rate of return)? Excel says 2.85* percent per year.
So, what is your discount rate? If your rate is lower than 2.85percent, then the implied present value of the payment stream is
higher than 339.8. If lower, higher. Such is the conventional wisdom.
And is this right? Well, there's taxes. Not really my department, though I think you have to pay tax on the lump sum payment at the front end, but on the payments only as they come in, which seems to tilt the advantage towards payments. And I suppose with this kind of money, you may be able to get some Mitt Romney action.
Oh, wait--the "I" word, "inflation." I gather that discount rate is based on the long-term treasury rate. The rate is supposed to "impound" inflation. But it looks to me like the inflation rate is already running close to 3 percent--low by historical standards but still high enough to eat up all of the implied discount rate. And what are the chances that inflation in the future will stay that low, huh? Huh?
Short answer: take the money and run. What say you?
[h/t: Buce's friend Bruce.]