Question

CASE

Billy Wilson, All American

In his senior year at a major Midwestern university, Billy Wilson had been the third runner up for the famed Heismann Tophy. The trophy goes to the outstanding football player in America and is presented annually by the New York Athletic Club. During the past football season, Wilson had run for over 1,500 yards and scored 18 touchdowns. He also caught 41 passes coming out of the backfield. His time in running the 40-yard dash, which professional scouts consider to be extremely important, was 4.38 seconds. He was voted first team All American by the Associated Press and was a second team All American in the Coaches Poll selections.

On Monday morning, his agent, Joel Weinberg, called to say that he was looking at three different proposals that a major West Coast professional football team had made for Billy Wilson’s services. The team had drafted him in the first round of the National Football League draft as the sixth player to be selected out of the thousands of college football players that were eligible for that year. The Edmonton, Alberta, team of the Canadian Football League was also interested in Wilson’s services. The Canadian team had called his agent over the weekend to put its offer on the table. While the National Football League (NFL) team that had drafted Billy Wilson in the first round had exclusive rights overall other U.S. teams in signing Billy Wilson during the current year, the Canadian team was not bound by such an arrangement and could make any offer it wished and hope the outcome would be positive.

Actual Proposals:

The West Coast NFL team offered the following three proposals. The team’s general manager, who was in charge of contract negotiations, said his team would stand behind any of the three offers and it was up to Billy Wilson and his agent to choose which they preferred:

Contract offer 1:

• • $900,000 immediate signing bonus
• • $850,000 at the end of each year for the next five (5) YEARS

Contract offer 2:

• • $200,000 immediate signing bonus
• • $100,000 at the end of each year for the next four years.
• • $150,000 a year at the end of years 5 through 10
• • $1,000,000 a year at the end of years 11 through year 40.

Contract offer 3:

• • $1,000,000 immediate signing bonus
• • $500,000 at the end of year 1
• • $1,000,000 at the end of year 2
• • $1,500,000 at the end of year 3
• • $2,000,000 at the end of year 4

Canadian Football League:

• • $1,100,000 immediate signing bonus
• • $2,000,000 at the end of each year for the next three years.

Required Assignment

Assume that the cash flows will be discounted using a 10 percent interest rate.

3. If the discount rate used was 7 percent instead of 10 percent, how might that change your answer? Would the resulting present values you calculated in #2 above be higher or lower – explain your answer.

Answer 1

3. We can see that in case of discount rate of 10% the Canadian Football League has the highest net present value. But when the discount rate is changed to 7% then the present value of all options increases and the most lucrative offer becomes the contract offer 2. The present value is higher as the rate of discount has declined and hence the cash flows will now be discounted less.

	PVs at 10%		PVs at 7%
Offer 1	4,122,168.75		4,385,167.82
Offer 2	4,597,675.41		7,392,303.97
Offer 3	4,773,990.85		5,090,965.69
Offer 4	6,073,703.98		6,348,632.09

Present values with a discount rate of 10%:

Offer 1:

Year	Cash flow	1+r	PVIF	PV
0	900,000.00	1.10	1.0000	900,000.00
1	850,000.00		0.9091	772,727.27
2	850,000.00		0.8264	702,479.34
3	850,000.00		0.7513	638,617.58
4	850,000.00		0.6830	580,561.44
5	850,000.00		0.6209	527,783.12
			Total	4,122,168.75

Offer 2:

Year	Cash flow	1+r	PVIF	PV
0	200,000.00	1.10	1.0000	200,000.00
1	100,000.00		0.9091	90,909.09
2	100,000.00		0.8264	82,644.63
3	100,000.00		0.7513	75,131.48
4	100,000.00		0.6830	68,301.35
5	150,000.00		0.6209	93,138.20
6	150,000.00		0.5645	84,671.09
7	150,000.00		0.5132	76,973.72
8	150,000.00		0.4665	69,976.11
9	150,000.00		0.4241	63,614.64
10	150,000.00		0.3855	57,831.49
11	1,000,000.00		0.3505	350,493.90
12	1,000,000.00		0.3186	318,630.82
13	1,000,000.00		0.2897	289,664.38
14	1,000,000.00		0.2633	263,331.25
15	1,000,000.00		0.2394	239,392.05
16	1,000,000.00		0.2176	217,629.14
17	1,000,000.00		0.1978	197,844.67
18	1,000,000.00		0.1799	179,858.79
19	1,000,000.00		0.1635	163,507.99
20	1,000,000.00		0.1486	148,643.63
21	1,000,000.00		0.1351	135,130.57
22	1,000,000.00		0.1228	122,845.97
23	1,000,000.00		0.1117	111,678.16
24	1,000,000.00		0.1015	101,525.60
25	1,000,000.00		0.0923	92,296.00
26	1,000,000.00		0.0839	83,905.45
27	1,000,000.00		0.0763	76,277.68
28	1,000,000.00		0.0693	69,343.35
29	1,000,000.00		0.0630	63,039.41
30	1,000,000.00		0.0573	57,308.55
31	1,000,000.00		0.0521	52,098.68
32	1,000,000.00		0.0474	47,362.44
33	1,000,000.00		0.0431	43,056.76
34	1,000,000.00		0.0391	39,142.51
35	1,000,000.00		0.0356	35,584.10
36	1,000,000.00		0.0323	32,349.18
37	1,000,000.00		0.0294	29,408.35
38	1,000,000.00		0.0267	26,734.86
39	1,000,000.00		0.0243	24,304.42
40	1,000,000.00		0.0221	22,094.93
			Total	4,597,675.41

Offer 3:

Year	Cash flow	1+r	PVIF	PV
0	1,000,000.00	1.10	1.0000	1,000,000.00
1	500,000.00		0.9091	454,545.45
2	1,000,000.00		0.8264	826,446.28
3	1,500,000.00		0.7513	1,126,972.20
4	2,000,000.00		0.6830	1,366,026.91
			Total	4,773,990.85

Offer 4 i.e. Canadian Football League:

Year	Cash flow	1+r	PVIF	PV
0	1,100,000.00	1.10	1.0000	1,100,000.00
1	2,000,000.00		0.9091	1,818,181.82
2	2,000,000.00		0.8264	1,652,892.56
3	2,000,000.00		0.7513	1,502,629.60
			Total	6,073,703.98