Question

PROBLEM #1_________(10 PTS.) Assume that you are an agent for the Seattle Mariner’s next superstar and that you are negotiating with a number of major league baseball teams concerning the superstar’s next contract. The Mariners are hopeful that the superstar will sign with them and have offered a package containing the following:- Signing Bonus at the start of Year 1: $10,000,000 -7-Year contract paying $12,000,000 per year -A lump-sum payment made at the end of 10 years of $5,000,000

The Los Angeles Dodgers have countered with an attractive package of their own which includes:-Signing Bonus at the start of Year 1: $1,000,000 -7-Year contract paying $15,000,000 per yearREQUIRED:1. Which contract is the best “financial deal?

Explain. Show Computations. Use an interest rate of 10%.

Answer 1

Present value of cash flow is a technique that uses time value of money concept to evaluate the alternatives.

PV discounts the future cash flow using the interest rate.The alternative with higher present value is selected.

Alternative (1)

Cash flow	Discount factor at 10%	Present value of cash flows
$10,000,000	1	$10,000,000
$12,000,000	4.8684[1/1.10]^1+[1/1.10]^2+[1/1.10]^3+[1/1.10]^3+[1/1.10]^4+[1/1.10]^5+[1/1.10]^6+[1/1.10]^7	$58,420,800[$12,000,000*4.8684]
$5,000,000	0.38554[1/1.10]^10	$1,927,716[$5,000,000*0.38544]
	Present value	$70,348,516

Alternative (2)

Cash flow	Discount factor at 10%	Present value of cash flows
$10,000,000	1	$10,000,000
$15,000,000	4.8684[1/1.10]^1+[1/1.10]^2+[1/1.10]^3+[1/1.10]^3+[1/1.10]^4+[1/1.10]^5+[1/1.10]^6+[1/1.10]^7	$73,026,000[$15,000,000*4.8684]
	Present value [10,000,000+73,026,000]	$83,026,000

Alternative 2 ( Los Angeles Dodgers ) should be selected as it have a higher present value than alternative 1.