Question

Harvey Alexander, a professional football player, has just declared himself a free agent. Two teams, the Pittsburgh Steelers and the Miami Dolphins, have made Harvey the following offers to obtain his services:

Pittsburgh Steelers:

• $1 million signing bonus payable immediately and an annual salary of $1.5 million for the 5-year term of the contract.

Miami Dolphins:

• $2.5 million signing bonus payable immediately and an annual salary of $1 million for the 5-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.

You have been hired as a consultant to Harvey’s agent, Phil Marks, to evaluate the two contracts. State your recommendation including the method you used to reach your conclusion. Explain any calculations with the use of Excel. 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

We need to calculate the present value of both the options at 8% for 5 years

Pittsburgh Steelers

Year	Amount	PV Factor	Present Value
	(in Million)	1 / (1+8%)^Year
0	$       1.00	1	$             1.00
1	$       1.50	0.92593	$             1.39
2	$       1.50	0.85734	$             1.29
3	$       1.50	0.79383	$             1.19
4	$       1.50	0.73503	$             1.10
5	$       1.50	0.68058	$             1.02
			$             6.99

Miami Dolphins

Year	Amount	PV Factor	Present Value
	(in Million)	1 / (1+8%)^Year
0	$       2.50	1	$             2.50
1	$       1.00	0.92593	$             0.93
2	$       1.00	0.85734	$             0.86
3	$       1.00	0.79383	$             0.79
4	$       1.00	0.73503	$             0.74
5	$       1.00	0.68058	$             0.68
			$             6.49

If you see the above Pittsburgh Steelers is the best option since the Net Present Value is higher.