Question

A rookie quarterback is negotiating his first NFL contract. His opportunity cost is 10%. He has been offered three possible 4-year contracts. Payments are guaranteed, and they would be made at the end of each year. Terms of each contract are as follows:

1

2

3

4

Contract 1	$3,000,000	$3,000,000	$3,000,000	$3,000,000
Contract 2	$2,000,000	$3,000,000	$4,000,000	$5,500,000
Contract 3	$7,000,000	$1,500,000	$1,500,000	$1,500,000

As his adviser, which contract would you recommend that he accept?

Select the correct answer.

a. Contract 3 gives the quarterback the highest future value; therefore, he should accept Contract 3.

b. Contract 3 gives the quarterback the highest present value; therefore, he should accept Contract 3.

c. Contract 1 gives the quarterback the highest present value; therefore, he should accept Contract 1.

d. Contract 1 gives the quarterback the highest future value; therefore, he should accept Contract 1.

e. Contract 2 gives the quarterback the highest present value; therefore, he should accept Contract 2.

Answer 1

The present value is computed as follows:

= Future value / (1 + r)ⁿ

Present value of contract 1 is computed as follows:

= $ 3,000,000 / 1.10 + $ 3,000,000 / 1.10² + $ 3,000,000 / 1.10³ + $ 3,000,000 / 1.10⁴

= $ 9,509,596.339

Present value of contract 2 is computed as follows:

= $ 2,000,000 / 1.10 + $ 3,000,000 / 1.10² + $ 4,000,000 / 1.10³ + $ 5,500,000 / 1.10⁴

= $ 11,059,353.87

Present value of contract 3 is computed as follows:

= $ 7,000,000 / 1.10 + $ 1,500,000 / 1.10² + $ 1,500,000 / 1.10³ + $ 1,500,000 / 1.10⁴

= $ 9,754,798.17

So, the correct answer is option e i.e. Contract 2 gives the quarterback the highest present value; therefore, he should accept Contract 2