How would you answer this case interview question
Had a first round phone interview with a consulting firm. As most first round interviews go, it consisted of mostly fit questions. However, the interviewer threw in one case question, probably just to see how I think on my feet and to make sure I wasn't a complete dumbass.
The interview asked, "If you won the lottery and had the options of taking the winnings in one lump sum or ten equal payments over ten years, what factors would you base you decision on?".
Without getting into too much detail, I said the following (in this order).
- Tax implications
- expected future inflation rates
- expected future interest rates
- personal spending decisions (i.e. blow it all at once, invest it, etc)
Just wondering how you all would answer this question and if you think how I responded was reasonable.
Thanks.
I disagree with the above answers
First, lottery winnings are not taxable so whether you get it as one lump sum or ten equal payments does not have any tax implications.
Secondly, the way you stated the question it is either say 1m immediately or 100k every year for 10 years.
Inflation or future interest rates are irrelevant here as only an idiot would accept the 2nd deal. Inflation and interest rates are only relevant if you were offered a HIGHER nominal value of receipts in the case of the 2nd deal. So say you were offered either 1m immediate or 200k every year for 10 years. Then, there is a NPV calculation to make but in your case with positive deposit interest rates, only an idiot would choose the 2nd option.
Hence, rates and inflation don't matter.
As such, you will ALWAYS choose the first option - and hence, the credit history of the issuer is also irrelevant.
Either the question is very tricky, or the interviewer did not think about the numbers properly (which is more likely and in which case your answer is the mainstream answer and would be perfect)
Wrong! Lottery winnings ARE taxable.
http://www.irs.gov/taxtopics/tc419.html
Therefore, the original poster was correct to consider tax implications, interest rates and inflation.
Right. If the interviewer meant 1m vs 10 pay of .1m, then its a classic time value of money problem and the clear answer is upfront.
lol I dont think 10 equal payments over 10 years means it equals the original amount. It merely says that the 10 payments are EQUAL to each other. I guess the most important to ask is whether the payments would equal the original amount, and if they do then you most likely take the lump sum.
Also incorrect on the other point, lottery winnings are generally taxable, so taxes should certainly be a consideration. At the very least, whether taxes will go up or down in the future.
OP writes: "If you won the lottery and had the options of taking the winnings in one lump sum or ten equal payments over ten years, what factors would you base you decision on?".
ONE LUMP SUM vs 10 EQUAL PAYMENTS OVER 10 YEARS.
Given that the value of the payments is not specified, it is plausible to assume the interviewer meant 1/10th of the LUMP SUM. Can't see any reasons to LOL here.
lol, I'm pretty sure that although lottery winnings may not be subject to state taxes, they are fully taxable for federal income taxes.
lottery winnings are without a doubt taxable in my state
Lol, sucks for you then. Also, note how I also used the words "may not be."
Apologies guys - in the UK, lottery winnings are not taxable iirc. No clue about the US ;)
while all the other points are correct in their own right, the main point that the interviewer was probably trying to get at was the discount being applied to the lump sum payment, which unfortunately wasn't stated in the OPs answer.
That is the meat of the question, everything else is supplementary and probably not really necessary. All the other points aren't the core question and are kinda distracting to tell you the truth.
You're right - if you take a lump sum it's going to be taxed extremely disadvantageously. I stated that in my reply to the interviewer. I simply did not want to get into the details of all my points in my post. Hence, why point #1 was "tax implications".
But no doubt, there is going to be a 40-50% discount on the lump sum payment. Thanks for bringing this up.
I seriously doubt they would be interested in taxation intricacies for first round consultancy interview. Much more likely, it is a "time value of money" kind of question and not "taxation question"
A very obscure answer which would have wowed the interview would have been to talk about pre-commitment. You alluded to it a bit with "personal spending decision"
http://www.princeton.edu/~tleonard/papers/paternalism.pdf
This paper talks about it a bit, but the idea is this: even if the 10 equal payments have a lower net present value, it doesn't follow that they are an inferior choice. Someone might pick that payment option because they don't trust themselves to actually space out their spending (i.e. they are afraid that they'll buy stupid shit like yachts or expensive watches.) So to prevent this, they pay the government (in the form of inflation) to give them the money in small increments. Presumably the smaller payments will lead to better purchases and more utility than spending $1mm on a Lamborghini
This is the same reason why people opt to defer their income tax refunds or sign up for fat camps; it's paying for someone to impose discipline. They don't trust themselves to behave so they make others do it for them.
Of course, WSO users are mostly econ/finance/mathy people so they would just take the lump-sum and invest it, but not all people would behave this way.
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