Question

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 five years or a smaller lump sum now. Advise O'Reilly on his choice under the following scenarios. Which option should he take and why? Use Exhibit 31. a. O'Reilly's after-tax return is 10 percent. If he chooses the current lump-sum option, the lottery will pay him $130 million b. O'Reilly's after-tax return is 10 percent. His current tax rate will be 35 percent if he receives the lottery payment now. His expected tax rate in five years will be 40 percent. If he chooses the current lump-sum option, the lottery will pay him $100 million Essay Toolbar navigation

Answer 1

Answer :

in Million $ 200.00 Jackpot Option a Lumpsum Tax Rate All inflow Is assumed to be received at year end in Million 130 35% 45.5 Tax 84.5 Net of Tax PVF @10% PV 0.909 76.81 Option b Year Lottery 1 $ 40.00 2 $ 40.00 3 $ 40.00 4 $ 40.00 5 $ 40.00 in Million Tax Rate Tax Net of Tax PVF @ 10% PV 35% $ 14.00 $ 26.00 0.909 $ 23.64 40% $ 16.00 $ 24.00 0.826 $ 19.83 40% $ 16.00 $ 24.00 0.751 $ 18.03 40% $ 16.00 $ 24.00 0.683 $ 16.39 40% $ 16.00 $ 24.00 0.621 $ 14.90 $ 92.80

Present Value of inflow after Tax is higher in option B which is five year Plan.