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.

jeff jeffy answered 2 years ago

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