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a) a dollar today
b) a dollar ten years from now
Costs: upfront
Benefits: delayed, protracted
"What is the most I'd be willing to pay today, in exchange for $1 a year
from today?"
X*(1+i)
X*(1+i) = 1
i.e.
X = 1/(1+i)
X = 1/(1+.05) ≈ .95
X(1+i)
[X(1+i)](1+i)
or
X(1+i)2
To find out how much we'd need to invest today at interest rate i to
produce $1 after 2 years, solve the following for X
X(1+i)2 = 1
i.e.
X = 1/(1+i)2
X = 1/(1.05)2 ≈ $.91
If you invested $.91 today at interest rate 5%, you'd have $1 after two
years.
PV = k/(1+i)n
Define:
Decision rule:
Answer:
1
PV = 20
(1 + i )
let i = .1 ⇒ PV = 148,000
Important Fact:
i) i = .05
ii) i = .1
=$1474.11
= 1258.14
ii) What profit does the Lottery make on this transaction? Explain.
Note: other ways the state profits off the lottery include
a) The sum they pay out is less than the sum they take in
b) Lottery winnings are taxable