You have just won a lottery prize. You can choose to receive $750,000 today or an annual payment of $50,000 at the end of each of the next 20 years. The interest rate that makes you indifferent between the two is 2.91%, and at higher rates you should take the lump sum.

Question

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The interest rate that makes the present value of the annuity equal to the lump sum is known as the break-even rate. If the given rate of 2.91% makes the present value of receiving $50,000 annually for 20 years equal to $750,000, then at any rate higher than 2.91%, the present value of the annuity would be less than $750,000, making the lump sum the better option.

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