Allen B. Atkins, Roxanne Stell, & Larry Watkins

Allen B. Atkins, Roxanne Stell, & Larry WatkinsBob, Chad and Dylan had been dreaming of this day for the past six years; eversince they first met in an introductory economics course in college. For severalyears they had been pooling their money and buying Arizona Lottery ticketsdreaming that one day they would win big. They realized that the lottery wasconsidered by many to be a voluntary tax on the statistically challenged. Butmiraculously they now sat at their favorite local “watering hole” holding thewinning ticket that meant they would split “The Pick” jackpot of $6 million.What a great feeling! Now they just needed to decide if they wanted to taketheir winnings as a lump sum now or to be paid over the next twenty in installments.Bob had been a political science major in college but things hadn’t worked out ashe anticipated when he was a student. He had entered the job market at whatlooked now to be the bottom of the economic downturn following the housingcrisis in the U.S. Bob believes he did not start his job search soon enough andfound suitable openings virtually nonexistent. He was currently working part-time at an organic farm and still living at home which cramped his style consider-ably. He has $150,000 in college related loans (7% interest rate) which he cannotservice based on his annual taxable income of $15,000. His share of the jackpotwould allow him to be debt free and change his life for the better without doubt.Chad had been more fortunate than Bob. He had applied himself in college andearned a master of accounting degree with an emphasis in taxation. Aftergraduation he immediately went to work for one of the international accounting firms and was now earning a taxable income of $100,000 in spite of the economic issues facing his friend Bob and the country as a whole. He too had debt but not from student loans. Chad had purchased a very nice home in Anthem, Arizona for approximately 50% of what it had sold for three years earlier when built. He had a $250,000 mortgageon the home, at a 4% interest rate, which he saw little reason to pay off since he anticipated significant inflation in the near future.Of the three friends Dylan was by far the most successful. Dylan had majored in finance and had excelled. When he graduated, although he had several attractive offers in the financial services industry, he decided to go into the family business. The company which his father and uncle had started nearly 50 years ago had done amazingly well inthe downturn and since he was the only child/nephew they were rewarding himhandsomely. He had been reluctant to tell Bob but he was on track to receive to-tal compensation (including bonuses) that yielded a taxable income of $300,000this year. Unlike his friend Bob, Dylan was frugal and had taken on zero debt.He was pleased with the trio’s good fortune but he didn’t think the windfall would change his life all that much. A few days later when the euphoria of winning was subsiding the three friends met again at the same establishment. All four were obviously in good spirits and were looking forward to presenting their winning ticket to Arizona Lottery officials.Chad started the conversation by telling Bob and Dylan that he had taken the initiative of doing some basic research on how “The Pick” worked and what the payout options were. Bob, proud of his forethought, produced an article he had saved years earlier from the Arizona Daily Star with the headline “Lump-sum Lotto Payout is Best, Experts Say.”Bob excitedly told his buddies that the experts were local CPAs and that clearly the lump-sum payout was “the way to go.” Dylan said he wanted to hear what Chad had found out since he had gone to the effort of looking into the specifics. Chad (being a tax accountant) had prepared a summary of his research whichfollows:”A percentage of the proceeds from the sale of Lotto tickets are allocated to a prize pool. The size of the Jackpot that is prominently advertised, six million dollars in this instance, is actually only an estimate. The advertised amount is the sum of the estimated annuity1 payments, without consideration of the time value of money, which Lotto officials believe can be purchased from the prize pool. If the winner chooses the annuity payout multiple insurance companies submit bids. Officials award the bid to the insurance company that offers the largest annual payments in return for the prize pool amount. The insurance company with the best bid typically offers a rate that is near the long term U.S. Treasury Bonds rate (currently 3%). If the winner chooses the Lump Sum payout they simply receive the prize pool amount; the amount that would have beenused to buy the annuity.”The term annuity is actually a misnomer. Sincethe payments are made by the insurance companyat the beginning of each of twenty periods itis an annuity due.After reading the summary Bob said he didn’t see how this related to the decision that had to be made since he didn’t see anything that changed the preferred option being that the lump-sum payout is best. Chad acknowledged that Bob was probably correct but he still wanted to “run the numbers” and suggested that Bob and Dylan should do the same. Chad reminded them that they needed to consider the tax consequences of the payout schema and then provided the following schedule of federal income taxrates and reminded them that the state tax rate was an additional 5%.Bob rolled his eyes but said he would get right on it. Dylan thanked Chad for the information and they agreed to meet again tomorrow to decide on the best course of action.Questions1. Prepare a personal analysis of the payout options for Bob, Chad andDylan. Designate the preferred option for each individual and explain why.Taxable Income Bracket* Marginal Federal Tax Rate$0$8,50010%$8,501$34,50012%$34,501$83,60025%$86,601$173,40028%$173,401$379,15033%$379,151Or over25%*Assumes individual filing status