Your Uncle Otto Has Struck It Rich by Investing in Racehorses

question 4

Essay

Your Uncle Otto has struck it rich by investing in racehorses and desires to share some of his newfound wealth with you. Assume that you must choose from among the following three options:
Receive a lump sum of $400,000 in 20 years.
Receive $20,000 at the end of each year for the next 10 years.
Receive $90,000 now.
Required:
A. Why is it inappropriate to compare $400,000 (no. 1) vs. $200,000 (no. 2) vs. $90,000 (no. 3) and conclude that no. 1 is the best option? Explain.
B. What should you do to determine which option is the best? What does this process do?
C. If Uncle Otto agreed to revise option no. 1 so that you could receive $200,000 in 10 years and the remaining $200,000 in another 10 years, would you likely prefer the revision or the option as originally stated? Why?
D. What is an annuity? Do any of the options involve an annuity?

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Definitions:

Homemade Dividends

The concept where investors sell a portion of their portfolio to create cash flow, as an alternative to relying on traditional dividends from investments.

Dividend Policy

A company's strategy or guidelines for making dividend payments to its shareholders.

Share Value

The price at which a particular share of stock is traded on the market, determined by supply and demand.

Ex-dividend Date

The date on which a stock trades without its dividend, meaning that the seller is entitled to the dividend, not the buyer.