You win the lottery. How much do you actually take home?
Lesson 1: the time value of money. The ticket shows one big number, but you choose between a smaller amount of cash now or 30 yearly payments. Which is worth more?
Cash now
$230.0M
In your account today
30 yearly payments
$500.0M
Added up: the advertised number
Those payments, worth today
$225.8M
At 5% a year
If you can earn 5% a year, the cash now is worth more.
The tipping point is about 4.9% a year: earn more than that and the cash wins.
Each yearly payment, years 1 to 30
The idea underneath: a dollar today beats a dollar later
The payments add up to more than the cash, so why would anyone take the cash? Because money you have today can be invested and grow. A payment you receive in year 20 has had no chance to grow for you yet.
To compare them fairly, finance converts every future payment into what it's worth today. That's called its present value. A payment received n years from now, at a yearly return of r, is worth:
Present value = Payment ÷ (1 + r)n
At 5%, $1 million arriving in 20 years is worth about $377,000 today. Add that up for all 30 payments and you get the “worth today” number above. The same math prices bonds, pensions, mortgages and company valuations.
Up next · Lesson 2
It's not that simple: taxes come out first
Taxes take a big bite out of both choices, and not the same bite. The cash is taxed all at once, while each yearly payment is taxed in its own year. That can change which option wins. Ready for lesson 2: how do taxes work?
Lesson 2 is coming soon. Join to get it when it's out.