Yet, the decision to gamble is —or should at least be treated as — a business decision. Given simi-lar odds, a gambler should skip a million-dollarlottery and risk his or her money, instead, ongambles that pay out immediately, for example,the slots or horse races. Yet, the marketing be-hind million-dollar prizes does everything possibleto discourage this kind of rational thinking.Table 1 shows how compound interest and taxesshrink the prize actually received by a million-dollar scratch-ticket winner. We apply a discountrate of 4.22%, based on assumptions about thewinner’s investment strategy, detailed below in theAppendix. We also reduce the annual payout by$15,142.51 to account for an estimated combinedfederal and state tax rate of 30.29% on the win-nings. The third column of Table 1 shows theNet Present Value (NPV) of the resulting annualafter-tax payout of $34,857.49 over the 20-yearpayout period.The present value of the combined20 payments is $484,310.01, less than half theadvertised million-dollar prize.
There can be only one motive for spreadingthe winnings out over 20 years: The cost tothe state of paying out later is less than thecost of paying out now. If the state pays outnow, the cost (taking into account the taxes itcollects on the winnings) is $947,000. If it paysout over 20 years, the cost is$657,881 inpresent-value terms.
In the corporate world, chief financial officersare never deceived by the high cost of factor-ing their accounts receivable. They under-stand the time value of money and the highcost of waiting for customers to pay. Con-sumers on the other hand are largely unawareof the compound interest factor and the dev-astating effect of the time value of money.Consider the rent-or-buy decision as it affectshousing. It seems unlikely that home buyersseriously consider the fact that they will endup paying two times the purchase price of ahouse by the time they finish paying princi-pal and interest. Rather, they commit them-selves to 30 years of mortgage payments inthe (perhaps illusory) hope that their housewill appreciate in value.Lottery prize winners display the same indif-ference to discounting scratch tickets; they donot seem to know, or even care, that million-dollar scratch tickets are subject to com-pound-interest shrinkage. The dominant at-traction of these scratch tickets is that theyoffer “instant winnings” to players. The tick-ets emphasize this feature. Players don’t haveto wait to find out whether or not they havewon. And the possibility of striking it rich fora “million dollar prize” is part of the packageand becomes a powerful psychological moti-vator.There is a further anomaly that characterizesthe decision to bet on a million-dollar prize.Prizes below a million dollars are paid out in-
Present 50,000.00 34,857.49 34,857.491 50,000.00 34,857.49 33,446.702 50,000.00 34,857.49 32,093.003 50,000.00 34,857.49 30,794.104 50,000.00 34,857.49 29,547.765 50,000.00 34,857.49 28,351.876 50,000.00 34,857.49 27,204.387 50,000.00 34,857.49 26,103.338 50,000.00 34,857.49 25,046.859 50,000.00 34,857.49 24,033.1210 50,000.00 34,857.49 23,060.4211 50,000.00 34,857.49 22,127.0912 50,000.00 34,857.49 21,231.5413 50,000.00 34,857.49 20,372.2314 50,000.00 34,857.49 19,547.7015 50,000.00 34,857.49 18,756.5416 50,000.00 34,857.49 17,997.4117 50,000.00 34,857.49 17,268.9918 50,000.00 34,857.49 16,570.0619 50,000.00 34,857.49 15,899.42
SUM 1,000,000.00 697,149.80 484,310.01