9:30 AM Class Group 1

THE LOTTERY PROJECT By: Jeffrey Albert, Julian Chan, Joshua Sanford, and Zack Byler Given Information: There are numerous games in the Connecticut lottery, each of which would be considered a scam if run by a private business. They all do pay out prize money, but the vast majority of bettors wind up losing. Winners of large prizes are given the option of being paid their winnings as a lump sum or in the form of an annuity. The lump sum is considerably less than the advertised winnings; the annuity consists of payments made annually until the advertised amount won is distributed. Consider a nominal prize of one million dollars, to be paid in twenty annual payments of $50,000. Assume when each payment is made, the recipient immediately pays Federal income tax at a 25% rate, Connecticut state income tax at a 5% rate and invests the rest. Assume the funds invested earn 6% per year, with both Federal and Connecticut state income taxes paid from that income and the remainder reinvested. Questions Asked: 1.) Determine the total amount of money the winner will have at the end of twenty years. This will be one year after the last payment. 2.) Determine the amount the winner would have had at the end of twenty years if he or she had been given one million dollars all at once under the same conditions regarding taxes and investment. 3.) Determine the amount for a lump sum payment that would leave the winner with the same amount as the annuity after twenty years. 4.) Analyze the pros and cons of lump sum payments vs. annuities. 5.) Discuss assumptions that were made to simplify this assignment along with important factors that have been omitted. Procedure: For Questions #1-3 our group set up 3 Microsoft excel spreadsheets to organize the data efficiently. For Question #1-3 we created three formulas to calculate the answers. Initial Interest = {Starting Balance + (50,000x0.7)}x0.06, Interest After Tax = (Initial Interest)x0.7, and Ending Balance = (Starting Balance) + (50,000x0.7) + Interest After Tax). By combining these formulas we were able to solve the first three questions. The first formula is designed to get us how much interest we would make before taxes on the amount we had. The second formula was designed to give us the amount of interest we would have after taxes. Finally, the third formula was designed to give us the ending balance for each year, which became our starting balance for the next year as well. For numbers four and five our group just brainstormed ideas and put them together. Questions 1-3 (See Spreadsheets) Question 4:Taking a Lump Sum vs. Annuity Lump sum Pros:  You have more control over your money, and you can decide how much you want to draw whenever you like.  You don‚t have to rely on scheduled income for cases that you might need extra cash.  You can invest your money. Cons:  Some people act on impulse and spend a lot of it right away.  Some people might not know the smartest way to manage their money and what investments to make.  Inflation  Financial markets could make a turn for the worst. Pros:  A check will come every month and you know the exact amount of money you‚ll receive per month.  You don‚t have to be concerned about where to put your money because the amounts you will be receiving aren‚t really large enough to invest. Cons:  Sometimes the size of the payment isn‚t enough to meet unexpected expenses.  Sometimes payments aren‚t always guaranteed, especially if your relying on a company. The company could go out of business.  There are organizations to help make the payments if that happens, but even those are limited. Question 5:Discuss assumptions that were made to simplify this assignment along with important factors that have been omitted. Our group had to assume that the interest rate wasn‚t changed over the course of 20 years. We also had to assume that the tax rates weren‚t changed and that the interest was taxed as well as the income. Furthermore, we had to assume that this money was going into some sort of savings account. If we were to put the money into a Roth IRA, then we wouldn‚t have had to pay taxes on the money in the account. Finally we had to assume that our money was safe in the account, because according to the FDIC, it‚s only safe up to $100,000.00. If this had been the case, then we would have had to create two separate accounts.