James Hardy recently rejected a $20,000,000, five-year contract with the Vancouv

Question

James Hardy recently rejected a $20,000,000, five-year contract with the Vancouver Seals. The contract offer called for an immediate signing bonus of $5,000,000 and annual payments of $3,000,000. To sweeten the deal, the president of player personnel for the Seals has now offered a $22,000,000, five-year contract. This contract calls for annual increases and a balloon payment at the end of five years.

Year 1-----------------------$ 3,000,000
Year 2--------------------------3,100,000
Year 3--------------------------3,200,000
Year 4--------------------------3,300,000
Year 5--------------------------3,400,000
Year 5 balloon payment-----6,000,000
Total---------------------------$22,000,000

Required

Suppose you are Hardy’s agent and you wish to evaluate the two contracts using a required rate of return of 12 percent. In present value terms, how much better is the second contract?

Explanation / Answer

calculation of present value
For rejected one(first one):

PV=$5000+{3000*(1/0.12-1/0.12(1.12)>5}
PV=15814.3286


For second Project:

PV=3000/1.12+3100/(1.12)>2+3200/(1.12)…
PV=14858.27

second alternative is less expensive $956.0586(15814.3286-1485.827). We should choose second option

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