Question

Pearl Hardy recently rejected a $19,863,000, five-year contract with the Vancouver Seals hockey team. The contract offer called for an immediate signing bonus of $7,363,000 and annual payments of $2,500,000. To sweeten the deal, the president of player personnel for the Seals has now offered a $22,021,000, five-year contract. This contract calls for annual increases and a balloon payment at the end of 5 years.

Year 1		$2,523,000
Year 2		2,600,000
Year 3		2,733,000
Year 4		2,800,000
Year 5		2,946,000
Year 5 balloon payment		8,419,000
Total		$22,021,000

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Suppose you are Hardy’s agent and you wish to evaluate the two contracts using a required rate of return of 14 percent. In present value terms, how much better is the second contract? (Round present value factor calculations to 4 decimal places, e.g. 1.2151 and final answers to 0 decimal places, e.g. 125. Enter negative amounts using either a negative sign preceding the number e.g. -45 or parentheses e.g. (45).)

Present value of old contract
Present value of new contract

In present value terms, the second contract is

Better or not better? than the old one.

Answer 1

Present value of old contract $15,946,000 Present value of new contract $13,619,512 In present value terms, the second contract is not better than the old one The present value is lower by -$2,326,488 Year Year 0 Year 1 Year 2 Cash flows Present value Present Old New old New value Contract Contract Contract Contract Factor 14% 1 $7,363,000 $7,363,000 $0 0.8772 $2,500,000 $2,523,000 $2,193,000 $2,213,176 0.7695 $2,500,000 $2,600,000 $1,923,750 $2,000,700 0.6750 $2,500,000 $2,733,000 $1,687,500 $1,844,775 0.5921 $2,500,000 $2,800,000 $1,480,250 $1,657,880 0.5194 $2,500,000 $2,946,000 $1,298,500 $1,530,152 0.5194 $8,419,000 $0 $4,372,829 $19,863,000 $22,021,000 $15,946,000 $13,619,512 Year 3 Year 4 Year 5 Year 5