Pearl Hardy recently rejected a $22,800,000, five-year contract
with the Vancouver Seals hockey team. The contract offer called for
an immediate signing bonus of $8,550,000 and annual payments of
$2,850,000. To sweeten the deal, the president of player personnel
for the Seals has now offered a $24,910,000, five-year contract.
This contract calls for annual increases and a balloon payment at
the end of five years.
| Year 1 | $2,850,000 | |
| Year 2 | 2,930,000 | |
| Year 3 | 3,010,000 | |
| Year 4 | 3,090,000 | |
| Year 5 | 3,340,000 | |
| Year 5 balloon payment | 9,690,000 | |
| Total | $24,910,000 |
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Suppose you are Hardy’s agent and you wish to evaluate the two
contracts using a required rate of return of 15 percent. In present
value terms, how much better is the second contract?
(Round present value factor calculations to 4 decimal
places, e.g. 1.2151 and final answers to 0 decimal places, e.g.
125. Enter negative amounts using either a negative sign preceding
the number e.g. -45 or parentheses e.g.
(45).)
|
Present value of old contract |
enter a dollar amount | |
|---|---|---|
|
Present value of new contract |
enter a dollar amount |
| In present value terms, the second contract is select an option betternot better than the old one. |
Answer : Below is the table showing Calulation of Present value under each Alternative :
Deal 1 : To receive immediate signing bonus of $8,550,000 and annual payments of $2,850,000.
| Year | Cash Flows | PVF @15% | Present Value of Cash Flows |
| 0 | 8550000 | 1 | 8550000 |
| 1 | 2850000 | 0.8696 | 2478360 |
| 2 | 2850000 | 0.7561 | 2154885 |
| 3 | 2850000 | 0.6575 | 1873875 |
| 4 | 2850000 | 0.5718 | 1629630 |
| 5 | 2850000 | 0.4972 | 1417020 |
| Total | 18,103,770 |
Deal 2 : New Contract
| Year | Cash Flows | PVF @15% | Present Value of Cash Flows |
| 1 | 2850000 | 0.8696 | 2478360 |
| 2 | 2930000 | 0.7561 | 2215373 |
| 3 | 3010000 | 0.6575 | 1979075 |
| 4 | 3090000 | 0.5718 | 1766862 |
| 5 | 3340000 | 0.4972 | 1660648 |
| 5 | 9690000 | 0.4972 | 4817868 |
| Total | 14,918,186 |
I present value terms, the second contract is not better as it results in loss of 3,185,584 (18103770 - 14918186) so select Deal 1
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