1. Suppose you are the agent for a Cricket batsman. Suppose he is offered the fo

Question

1. Suppose you are the agent for a Cricket batsman. Suppose he is offered the following contract by the Delhi Daredevils: a signing bonus of $3,000,000 (to be received immediately), a first year’s salary of $6,000,000 (to be received one year from today), a second year’s salary of $7,000,000 (to be received two years from today), and a third year’s salary of $8,000,000 (to be received three years from today). Suppose he is also offered the following contract by the Royal Challenger Bangalore: a signing bonus of $6,000,000, a first year’s salary of $5,500,000, a second year’s salary of $6,000,000, and a third year’s salary of $6,000,000. If you believe the relevant market interest rate is 10 percent, which offer would you advise the batsman to accept? Would your advice change if you believed the relevant market interest rate were 5 percent? (FYI: Cricket is a sport played worldwide. Delhi Dardevils, and Royal Challengers are a part of Indian Premier League (IPL), a professional league for Twenty Cricket competition in India. The league has 9 teams, consisting of players from around the world.)

Explanation / Answer

r = 10% Present value = Future value/(1+r)^t where r is the interest rate that is 10% and t is the time period Calculate the present value of cash flows from the contract from both teams. Select the contract with the higher present value DELHI DAREDEVILS Year 0 1 2 3 Cash flow 3000000 6000000 7000000 8000000 present value 3000000 5454545 5785124 6010518 Total present value 20250188 ROYAL CHALLENGERS BANGALORE Year 0 1 2 3 Cash flow 6000000 5500000 6000000 6000000 present value 6000000 5000000 4958678 4507889 Total present value 20466566 I would advice the batsmen to accept the contract from the ROYAL CHALLENGERS BANGALORE because the contract has a higher total present value.($20466566) r = 5% Present value = Future value/(1+r)^t where r is the interest rate that is 5% and t is the time period Calculate the present value of cash flows from the contract from both teams. Select the contract with the higher present value DELHI DAREDEVILS Year 0 1 2 3 Cash flow 3000000 6000000 7000000 8000000 present value 3000000 5714286 6349206 6910701 Total present value 21974193 ROYAL CHALLENGERS BANGALORE Year 0 1 2 3 Cash flow 6000000 5500000 6000000 6000000 present value 6000000 5238095 5442177 5183026 Total present value 21863298 When the market interest rate changes to 5%, I would advice the batsmen to accept the contract from the DELHI DAREDEVILS because the contract has a higher total present value.($21974193)

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