Question

Suppose two athletes each sign 10-year contracts for $80 million. In one case, we’re told that the $80 million will be paid in 10 equal installments. In the other case, we’re told that the $80 million will be paid in 10 installments, but the installments will increase by 5 percent per year. Who got the better deal

Answer 1

In case equal payments are received, we will receive $8million in each period. To calculate the present value we can discount the cash flow with the required rate of return

In case the payment will increase by 5% every year, and this also takes 10 years, the payments received at the beginning of the term will be lower than $8million. They payments at the end of the term will be higher than $8million. While, discounting, we will get a lower present value because the payment received at the end of the term will be discounted for a long period of time and will have a lower value.

PV of 10 years contract for $80 million,

10 equal installments > 10 installments, will increase by 5% each year

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