Question

Suppose that you are working for the Baltimore Orioles and trying to decide whether to hire John Jones or Steve Smith to play for the team.

John Jones is nearing the end of his career so will only play the 2017 season. Based on his past performance he will help the team and attract more fans to the stadium. In total John Jones will increase Orioles' revenues by $10 million (think of this as getting $10 million now in year 0).

Steve Smith is younger and will not play in 2017, but will play for the next three years (year 1, year 2, and year 3). However, he is expected to not be as good as John Jones and will only increase team revenues by $4 million in each of these years.

Use this information to answer the next four questions. Assume that only the numbers above are relevant to deciding who to hire.

1. Suppose the interest rate (r) is 10%. What is the present value of hiring Steve Smith?

2. When the interest rate (r) is 10% who should the Orioles hire?

Select one:

a. John Jones

b. Steve Smith

3. Suppose the interest rate (r) is 5%. What is the present value of hiring Steve Smith?

4. When the interest rate (r) is 5% who should the Orioles hire?

Select one:

a. John Jones

b. Steve Smith

Answer 1

(1) PV ($ Million) = 4 x P/A(10%, 3) = 4 x 2.4869** = 9.9476

(2) PV of increase in revenue from John Jones is higher, so John Jones should be hired.

(3) PV ($ Million) = 4 x P/A(5%, 3) = 4 x 2.7232** = 10.8920

(2) PV of increase in revenue from Steve Smith is higher, so Steve Smith should be hired.

**From P/A factor table