Question

You are Mr. Matthew Stafford’s agent and are negotiating a five year contract. The Lion’s make four offers: (a) $15 million a year for the next 5 years. (b) one-time payment of $95 million five years from now. (c) one-time payment of $50 million today. (d) $13.50 million at the beginning of each year for the next five years.  Which offer would you recommend that Mr. Stafford accept if the interest rate was 12.50%

  

Offer (a)

   

Offer (b)

   

Offer (d)

   

None of the above

        

Answer 1

a.Present value of annuity=Annuity[1-(1+interest rate)^-time period]/rate

=$15[1-(1.125)^-5]/0.125

=$15*3.560568342

=$53.41 million(Approx).

b.Present value of inflows=cash inflow*Present value of discounting factor(rate%,time period)

=$95/1.125^5

=$52.72 million(Approx).

c.Present value=$50 million

d.Present value of annuity due=(1+rate)*Annuity[1-(1+interest rate)^-time period]/rate

=1.125*13.5[1-(1.125)^-5]/0.125

=13.5*4.005639384

=$54.08 million(Approx).

Hence the offer to be taken is Offer D.