Question

Martinez Hardy recently rejected a $20,048,000, five-year contract with the Vancouver Seals hockey team. The contract offer called for an immediate signing bonus of $7,373,000 and annual payments of $2,535,000. To sweeten the deal, the president of player personnel for the Seals has now offered a $21,953,000, five-year contract. This contract calls for annual increases and a balloon payment at the end of 5 years.

Year 1		$2,456,000
Year 2		2,647,000
Year 3		2,678,000
Year 4		2,794,000
Year 5		2,945,000
Year 5 balloon payment		8,433,000
Total		$21,953,000

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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 16 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 = ?

Present value of new contract = ?

Answer 1

Solution :

Computation of Present Value of Old Contract
Period	Amount	PV factor	Present Value
0	$7,373,000.00	1	$7,373,000
1	$2,535,000.00	0.8621	$2,185,424
2	$2,535,000.00	0.7432	$1,884,012
3	$2,535,000.00	0.6407	$1,624,175
4	$2,535,000.00	0.5523	$1,400,081
5	$2,535,000.00	0.4761	$1,206,914
Total			$15,673,604

Computation of Present Value of New Contract
Period	Amount	PV factor	Present Value
1	$2,456,000.00	0.8621	$2,117,318
2	$2,647,000.00	0.7432	$1,967,250
3	$2,678,000.00	0.6407	$1,715,795
4	$2,794,000.00	0.5523	$1,543,126
5	$11,378,000.00	0.4761	$5,417,066
Total			$12,760,555

As present value of new contract is lesser than present value of old contract, therefore second contract is not better than first contract.