Question

A professional sport athlete, let’s call her Sue, has a nonguaranteed (meaning that she receives no salary if she is cut from the team or injured) contract that pays her $5 million per year for the next five years. Sue has been severely injured in an automobile accident and will no longer be able to work, let alone play for her team. When Sue sues the driver of the other vehicle in court, the jury awards her $25 million to cover the loss of earnings over the next five seasons. Given what we have learned in this chapter, was the jury correct? You must show your work and explain your position in detail.

Answer 1

Since Sue was expected to earn a continuous stream of $ 5 Mn per year for 5 years. According to Time value of money principle, if Sue is paid a sum that is greater than or equal to PV of future cash flows, then we can assume that the jury was correct.

Using current treasury rate to be the risk free rate , which is around 2.85%, we calculate the PV of Future cash flows

The PV value comes out to be $23 Mn.

The jury awarded her $25Mn , thus the jury was correct.