Question

A rookie quarterback is negotiating his first NFL contract. His opportunity cost is 9%. He has been offered three possible 4-year contracts. Payments are guaranteed, and they would be made at the end of each year. Terms of each contract are as follows:

1

2

3

4

Contract 1	$2,500,000	$2,500,000	$2,500,000	$2,500,000
Contract 2	$2,500,000	$3,500,000	$4,000,000	$5,000,000
Contract 3	$6,500,000	$1,000,000	$1,000,000	$1,000,000

As his adviser, which contract would you recommend that he accept?

Select the correct answer.

a. Contract 1 gives the quarterback the highest present value; therefore, he should accept Contract 1.

b. Contract 1 gives the quarterback the highest future value; therefore, he should accept Contract 1.

c. Contract 3 gives the quarterback the highest future value; therefore, he should accept Contract 3.

d. Contract 2 gives the quarterback the highest present value; therefore, he should accept Contract 2.

e. Contract 3 gives the quarterback the highest present value; therefore, he should accept Contract 3.

Answer 1

Solution

The best contract will be ,which will give highest total present value for the cashflows

Present value=Cashflow/(1+r)^n

where

r-reqd rate of return or opportunity cost-9%

n-number od discounting periods

Calculation for total present value of 3 contracts given below

Excel formula

Thus as it can be seen the Total Present value of contrat 2 is highest so it should be selected

Thus the correct answer is

Contract 2 gives the quarterback the highest present value; therefore, he should accept Contract 2.

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