October 1, 2014

The McDonald’s Monopoly $1,000,000 Prize Will Cost the Company Pennies on the Dollar

McDonald's Monopoly Game Pieces on FoodThe Monopoly game at McDonald’s has returned.  The top prize for collecting Boardwalk and Park Place is a cool $1,000,000 in cash.  The winner will not collect that money upfront.  Instead, he or she will be mailed a check for $50,000 each year for the next 20 years, without interest.  This steady payment is known as an annuity.  Given my calculation the other day of what it would take to own the entire Monopoly board in real life, I thought it would be useful to explain how this works.

Why would the McDonald’s Corporation make the $1,000,000 prize an annuity rather than a lump sum?  It comes down to the firm’s opportunity cost.  McDonald’s earns 15.12% on assets and 36.35% on equity.  Those are some very high rates of return relative to the average business.

That means that $1,000,000 in net worth at McDonald’s is generating an average after-tax return of $363,500 for the owners (the stockholders) each year.  It would be stupid for management to give up that kind of profitability.  By hanging on to the money as long as possible, McDonald’s can keep it invested at high rates of return and offset the cost of the Monopoly game grand prize.

How Much Will the Monopoly $1,000,000 Grand Prize Cost McDonald’s Corporation?

We can discount the cash flows of the annuity back to the present to find out how much the prize is really going to cost the restaurant.  Our “i” variable would be 36.35%, our “n” variable would be 20, and our “PMT” variable would be $50,000.

The net present value of the McDonald’s Monopoly $1,000,000 Grand Prize to the Company: $137,272.74

If McDonald’s were to give away $1,000,000 for the Monopoly game today, it would be giving away $1,000,000.  That would be the real cost of the transaction.  By spreading it out in installments over 20 years and keeping most of the money invested in the high returning McDonald’s restaurant business, the cost to stockholders is only $137,272.74.

But wait!  There is more.  You have to consider this is a marketing expense to the company.  Let’s give McDonald’s an average weighted tax rate of 35% in the United States.  That means the restaurant will be able to take a $48,045 tax credit for the expense of the promotion, leaving it with a net bill of roughly $89,228.

The real opportunity cost to McDonald’s for the $1 million prize?  $89,228

How Much Is the $1,000,000 Monopoly Grand Prize Worth to the Winner?

McDonald's Monopoly Big MacThat doesn’t mean this is the present value for person who wins the Monopoly grand prize!  You have to calculate the “true” intrinsic value to them based upon their own opportunity cost.  Say you won and you know you can earn 8% on your money.  Obviously, getting a lump sum up front is more valuable to you because you can put the cash to work and earn 8% interest each year.  That means your “i” variable would be 8%, not 36.35%.

The net present value of the McDonald’s Monopoly $1,000,000 Grand Prize to You: $490,907.37

But you’re going to have to pay taxes.  Let’s presume you are in the 30% bracket including everything – Federal, State, etc.  You are going to pay $147,272 in taxes, leaving you with only $343,635!

You can see how this is a win / win for the customer and for McDonald’s.  Management only has to come up with a real $89,228, most people think they are winning a full $1,000,000, which they aren’t (they are still getting a very nice $343,635 in after-tax net present value so it is unquestionably awesome to win!).

With logic like this, it isn’t difficult to see one of the reasons McDonald’s is able to generate such a high return on equity.  The finance staff knows what they are doing.

  • Austin H

    Joshua-

    I was just talking to my roommate about your article and he told me that it was a huge fraud. Check out the Wikipedia….

    http://en.wikipedia.org/wiki/McDonald%27s_Monopoly

    I had never heard about this before and figured you would be interested in this as well.

    -Austin

    • http://www.joshuakennon.com Joshua Kennon

      Oh yeah, I remember a bunch of people going to Federal prison over it. It was a huge deal because Wall Street was worried that it would undermine the consumer benefit of promotions. A few years ago they redid the entire process and brought it external auditors to ensure that it is 100% fair and random now. Everyone involved is sitting behind bars now.

  • Frat Man

    You know what would be absolutely awesome? If the million dollar McDonalds winners used the proceeds to buy up McDonalds franchises- that’s what I would do!

    • http://www.joshuakennon.com Joshua Kennon

      That’s funny. When I was a kid and the first McDonald’s game came out, I calculated how many shares of McDonald’s stock it would buy me. I dreamed of dividend checks from McDonald’s paid for by McDonald’s prize money, which I never wanted to spend … just to watch get bigger and bigger. I think all capitalist have a certain brain wiring.

  • BreezyG

    im so very confused…. if the winner is truly only winning $490,907.37 and is also going to be taxed 30% from that amount, where is the other $509,092.63. I’m not quite understanding this equation. Are they being taxed twice? If so why? also if they are going to send you a $50,000 check every year for 20 years, how do you not end up with $1,000,000 over an extended period of time? would the person not just take tax out of the $50,000 check for taxes at the end of that year? For example, where i live in MS if i make $50,000 or more i rank in the 32% tax racket. So i would need to take $16,000 from that $50,000 check and put it aside, added all up i would receive a total of $680,000 in 20 years. Would that $680,000 be taxed again?? If so why? Or if my whole knowledge on this is completely wrong, please explain how so that i may learn.

    • http://www.facebook.com/people/Andrew-Patton/592034163 Andrew Patton

      It’s not double taxation, but rather the time-value of money. If won the $1 million and wanted to spend the money today, you’d have to go to a bank or an insurance company and get them to lend you that money against the payments in the out years. Since they require interest in exchange for doing that, you’d get far less than $1 million (before figuring in taxes).

  • http://www.facebook.com/people/Andrew-Patton/592034163 Andrew Patton

    There is no 30% bracket, though you bring up another interesting matter: a $1,000,000 lump sum will be taxed in the year it is received, almost entirely at the 35% tax rate (it would be entirely at the 35% tax rate if the person normally pays 35% marginal taxes, but the vast majority of people are in the 15% tax bracket or less). If you receive the prize as an annuity, you’d pay taxes on each $50,000 payment in the year it was received, which based on current tax rates means you’d pay 15% if your total income including the prize does not exceed $90,200+$3800*however many kids you have if your status is married, filing jointly (singles will pay at least part of the prize at the 25% tax rate).

    Thus, the annuity payments are tax-advantaged compared to the lump-sum (assuming the rates hold), and this must be factored into the discounting of the future cash flows. Now for the arbitrage factor: your discount rate is not how much you could invest that money for today, but rather how much it would cost you to borrow it. In other words, the NPV of the payments is how much money you could borrow today against those payments. If you have good credit, you could take out a mortgage today at about 4% fixed for 20 years and then invest it in the stock market (diversified portfolio yields a long term average return of 8% a year), and the interest expense would be tax deductible. Don’t have the equity to do that? Well, then buy the equity by investing in rental properties.

  • Mark Colbath

    One more thing to consider, which has nothing to do with the cost to McDonald’s. If you consider the value of $50,000 in 20 years, you, the prize winner will only be getting $1069 that year. This is assuming a 5% inflation rate, higher than what the government reports, but lower than what we all know to be the real figure.

    Makes me realize why annuities are such a lucrative gig, for the dealers.

    • Joel

      I don’t “know” that the inflation rate is 5% now in 2013,it was close for a few months in 2008. If it were 5% and lasted 20 years at that rate, something that has rarely happened in the history of the world, the purchasing power would be $17,924.30 ($50,000 x 0.95^20 years). Not pretty but not as dismal as $1069.

  • Zarria Ivy

    I think I won $1,000,000 because I got the 1 million dollar Monopoly piece and I’m going to McDonald’s and see if I won or not today.