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O'Reilly is a masterful lottery player. The megamillion jackpot is now up to $200 million. If O'Reilly wins the jackpot, he has a choice of receiving $200 million in 5 years or a smaller lump sum currently. Advise O'Reilly on his choice under the following scenarios. Which option should he take and why?
a. O'Reilly's after tax return is 10%. If he chooses the current lump sum option, the lottery will pay him $130 million.
b. O'Reilly's after-tax return is 10%. His current tax rate will be 35% if he receives the lottery payment now. His expected tax rate in five years will be 40%. If he chooses the current lump sum option, the lottery will pay him $100 million.
Capital Budgeting
The process of allocating resources for significant capital, or investment, expenditures in the long term.
Discount Factor
A multiplier used in discounted cash flow (DCF) analysis to calculate the present value of future cash flows.
Profitability Index
A calculation that compares the present value of future cash flows to the initial investment, used in capital budgeting to determine the desirability of an investment.
Investment Projects
Projects undertaken by individuals or companies involving the investment of capital for future gain.
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