Question

In: Finance

A rookie quarterback is in the process of negotiating his first contract. The team's general manager...

A rookie quarterback is in the process of negotiating his first contract. The team's general

manager has offered him three possible contracts. Each contract lasts for four years.

All of the money is guaranteed and is paid at the end of each year. The payment

terms of the contracts are as follows:

(dollars in millions)

Year

Contract 1

Contract 2

Contract 3

1

$1.50

1.0

3.5

2

$1.50

1.5

0.5

3

$1.50

2

0.5

4

$1.50

2.5

0.5

The quarterback discounts all the cash flows at 12%. Which of the three

contracts offers the most value? (Hint: Calculate the present value of future cash flows)

Solutions

Expert Solution

Calculation of present value

- Contract 1

Year Cashflow ($ in millions) PVF@12% Cashflow*PVF
1                     1.50 0.89286 1.34
2                     1.50 0.79719 1.20
3                     1.50 0.71178 1.07
4                     1.50 0.63552 0.95

Present Value = Cashflow*PVF

= 1.34+1.20+1.07+.95

= 4.56 million

- Contract 2

Year Cashflow ($ in millions) PVF@12% Cashflow*PVF
1                     1.00 0.89286 0.89
2                     1.50 0.79719 1.20
3                     2.00 0.71178 1.42
4                     2.50 0.63552 1.59

Present Value = Cashflow*PVF

= .89+1.2+1.42+1.59

= 5.10 million

- Contract 3

Year Cashflow ($ in millions) PVF@12% Cashflow*PVF
1                     3.50 0.89286 3.13
2                     0.50 0.79719 0.40
3                     0.50 0.71178 0.36
4                     0.50 0.63552 0.32

Present Value = Cashflow*PVF

= 3.13+.4+.36+.32

= 4.20 million

Decision: Contract 2 offers the most value to the comapany hence preferrable.

jeff jeffy answered 2 years ago
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