Question

If we assume and interest rate of 5% would you rather have $1,000 today or receive $1, 120 in 3 years? Please explain why. Assume that two athletes sign 10 -year contracts that pay out a total of $100 million over the life of the contracts. One contract will pay the $100 million in equal installments. The other contract will pay the $100 million in installments, but the installments increase 5% per year. Which athlete received the better deal? Please explain why.

Answer 1

We will be trying to compare the the both alternatives by discounting at present value

=(1120/(1.05)^3)= 967.4

so we should rather accept $1000 today because it is having a higher present value.

2.Both the athletes should be compared at the present value as if the 5% of growth rate is is lower than the discounting rate say 8%, then the athlete which has received the money at the present value is better in taking at 1 installment.

Whereas if the discount rate adopted like 3% and the growth rate has been 5% then the athlete which has received in installment with the growth rate is having a better alternative.