Question

Harvey Alexander, an all-league professional football player, has just declared free agency. Two teams, the San Francisco 49ers and the Dallas Cowboys, have made Harvey the following offers to obtain his services:

49ers:	$1 million signing bonus payable immediately and an annual salary of $1.5 million for the five-year term of the contract.
Cowboys:	$2.5 million signing bonus payable immediately and an annual salary of $1 million for the five-year term of the contract.

With both contracts, the annual salary will be paid in one lump sum at the end of the football season.

Required:

You have been hired as a consultant to Harvey's agent, Phil Marks, to evaluate the two contracts. Write a short letter to Phil with your recommendation including the method you used to reach your conclusion. Assume that Harvey has no preference between the two teams and that the decision will be based entirely on monetary considerations. Also assume that Harvey can invest his money and earn an 8% annual return.

Answer 1

Solution:

Offer from 49ers = $1,000,000 immediately and $1,500,000 per annuam for 5 years

Offer from cowboys = $2,500,000 immediately and $1,000,000 per annuam for 5 years

Annual return on investment = 8%

In order to calculate best option base on monetary considerations, we have to calculate Present value of both options discounted at annual return of 8%. Option that will give higher present value, should be accepted by Harvey Alexendar as it will result in highest earning for alexendar.

Present value Earnings:

49 ers (Option 1) : ($1,000,000) + ($1,500,000 * cumulative PV factor for 5 years at 8%) = $1,000,000 + ($1,500,000 * 3.99271)

= $6,989,065

Cowboys (Option2) =

($2,500,000) + ($1,000,000 * cumulative PV factor for 5 years at 8%) = $2,500,000 + ($1,000,000 * 3.99271)

= $6,492,710

Therefore present value of earning for option 1 (49ers) is higher than present value of earnings of option 2 (Cowboys). Hence we will recommend Mr. Harvey Alexendar to accept offer of 49ers as it will result in higher earnings.