A baseball player is offered a 5-year contract that pays him the following amoun

Question

A baseball player is offered a 5-year contract that pays him the following amounts: Year 1: $1.39 million Year 2: $1.87 million Year 3: $2.12 million Year 4: $2.64 million Year 5: $3.50 million Under the terms of the agreement all payments are made at the end of each year. Instead of accepting the contract, the baseball player asks his agent to negotiate a contract that has a present value of $1.95 million more than that which has been offered. Moreover, the player wants to receive his payments in the form of a 5- year ANNUITY DUE. All cash flows are discounted at 11.00 percent. If the team were to agree to the player's terms, what would be the player's annual salary (in millions of dollars)? (Express answer in millions. $1,000,000 would be 1.00) Answer Format: Currency: Round to: 4 decimal places. Enter Answer Here... Submit Answer

Explanation / Answer

Step 1 Find out the present value of offer Year Payment Discount factor @ 11% Present Value 1 $1.39 0.90090 $1.25 2 $1.87 0.81162 $1.52 3 $2.12 0.73119 $1.55 4 $2.64 0.65873 $1.74 5 $3.50 0.59345 $2.08 Present Value of offer $8.14 Step 2 Player demand that the present value of would be more than $1.95 million more than that which has been offered.This counter offer has been accepted. The revised present value of new offer = $8.14 million + $1.95 million = $10.09 million This will be paid in equal amount for 5 Years. We can use the present value of annuity formula to calculate the yearly payment. Present value of annuity = P x {[1 - (1+r)^-n]/r} Present value of annuity = $10.09 P = Yearly payment = ? r = discount rate = 11% n = no.of years = 5 10.9 = P x {[1 - (1+0.11)^-5]/0.11} 10.9 = P x 3.695897 P = 2.7290 Player's Annual salary = $2.7290 million

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