James Hardy recently rejected a $20,000,000 five year contract with the Vancouve

Question

James Hardy recently rejected a $20,000,000 five year contract with the Vancouver Seals hockey team. The contract offer called for an immediate signing bonus of $7,500,000 and annual payments of $2,500,000. To Sweeten the deal, the president of player personnel for the Seals has now offered a $22,000,000, five-year contract. This contract calls for annual increases and a balloon payment at the end of five years.

Year 1                          $2,500,000

Year 2                            2,600,000

Year 3                            2,700,000

Year 4                            2,800,000

Year 5                            2,900,000

Year 5 baloon payment 8,500,000

Total                            $22,000,000

Required

Suppose you are Hardy's agent and you wish to evaluate the two contracts using a required rate of return of 15 percent. In present value terms, how much better is the second contract?   

Explanation / Answer

PV = FV/ (1+rate/100)^T

NPV of 1st contract = 7,500,000 + 2,500,000 / (1.15)+ 2,500,000 / (1.15)^2+ 2,500,000/ (1.15)^3+ 2,500,000/ (1.15)^4+ 2,500,000/ (1.15)^5

= 15,880,000

For 2nd contract

PV of 2nd contract = 2,500,000/(1.15) + 2,600,000/(1.15)^2 +2,700,000/(1.15)^3 +2,800,000/(1.15)^4 +2,900,000/(1.15)^5 + 8,500,000/(1.15)^5

= 13,183,904

So, contract 1 is better option as compared to 2nd.

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