Question
In: Finance
Boston Bruins – the ice hockey team - has offered Bobby Esposito the following two contract...
Boston Bruins – the ice hockey team - has offered Bobby Esposito the following two contract options. The first contract offer is $3 million a year for 5 years (first payment a year from now) plus a signing bonus of $1 million (paid immediately). The second five year contract offers a first-year payment of $2.5 million dollars (paid one year from now), but after that the payments grow at an annual rate of 12%. Assuming the interest rate is 5%, what is the PV of option A and of option B?Which contract should Mr. Esposito choose? (upload a file with your work and answer)
Solutions
Expert Solution
The present value of option A is calculated as follows
PV of option A = $ 1,000,000 + $ 3,000,000 
(1+0.05)1 + $ 3,000,000
(1+0.05)2 + $ 3,000,000
(1+0.05)3 + $ 3,000,000
(1+0.05)4 + $ 3,000,000
(1+0.05)5
PV of option A = $ 13,988,430.01
____________________________________________________
The cash flows of option B contract is as follows
| Year | Cash flows |
| 1 | 2,500,000 |
| 2 | 2,800,000 |
| 3 | 3,136,000 |
| 4 | 3,512,320 |
| 5 | 3,933,798 |
The present value of the cash flows option B = $ 2,500,000
(1+0.05)1 + $ 2,800,000
(1+0.05)2 + $ 3,136,000
(1+0.05)3 + $ 3,512,320
(1+0.05)4 + $ 3,933,798
(1+0.05)5
The present value of the cash flows option B = $ 13,601,457.97
________________________________________________________
Mr. Esposito should choose contract A because the present value of cash flows from contract A is higher than the present value of cash flows from contract B.
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