Question

Suppose a college junior could earn a salary of $2 million/year by declaring himself eligible for the NFL draft. If he waits until after his senior year he expects his salary to be $2.2 million. In both cases he will sign a 4-year contract, and plans to retire when this contract expires. His personal discount rate is 8%, also the current interest rate.

(a) Write out in detail his cash flow options and calculate the present discounted values of his options. Should he stay for his senior year, or not?

(b) Suppose that there is a 50% chance that the league will institute a $2 million rookie salary cap next year (and a 50% of no maximum). Recalculate his present discounted values; now what should he do?

(c) Now suppose the NFL has mandatory retirement after three years (but no salary maximum). Recalculate his present discounted values; now what should he do?

Answer 1

Junior salary = $2million /yr . �senior salary = $2.2million �discount rate = 8% �calculate of present value �here, PVAF = present value annuity factor . �PVF = present value factor �(i) Retire after 4years �in case as college junior = 2 times 1000000 times PVAF[8%, 4years] �= 2 times 1000000 times 3.312 �= 6624000 or $6.624million �In case he waits for senior year = 2 times 1000000 times PVAF[8%, 3yr] + 2.2 times 1000000 times PVF[8%, 4yr] �= 2 times 1000000 times 2.577 + 2.2 times 1000000 times 0.735 �= 6771000 or $6.771 million �b) If there are 50% chances that there would be a cap of $2 million & 50% chances that no such cap would be there, then present values = $6.62 times 0.5 + $6.771 times 0.5 = $6.6955million \r\n (i) junior salary = $2million /year �senior year = $2.2million/year �discount rate = 8% �cal. of present value [PV] �here PVAF = present value annuity factor �PVF = present value factor �