Greg McBrown has just signed a four year contract to play for a professional ice
ID: 2815622 • Letter: G
Question
Greg McBrown has just signed a four year contract to play for a professional ice hockey team. He will receive $2.5M this year, $3.5M next year, $3.7M in the third year, and $4.0M for the final year. Assume all payments are made at the end of each year.
(a) What is the present value of his contract if his discount rate is 4.5% EAR?
(b) If he wanted instead to receive equal monthly payments at the beginning of each month, with the first cheque today, how much would the monthly cheque be? Assume all interest rates are 4.5% EAR.
Explanation / Answer
Answer a Calculation of present value of contract Year Payment (in millions) Discount factor @ 4.5% Present Value (in millions) 1 $2.50 0.95694 $2.39 2 $3.50 0.91573 $3.21 3 $3.70 0.87630 $3.24 4 $4.00 0.83856 $3.35 Present Value of Contract $12.19 Answer b We can use the present value of annuity due to calculate the monthly cheque amount. Present value of annuity due = P + P x {[1 - (1+r)^-(n-1)]/r} Present value of annuity due = $12.19 million P = monthly payment = ? r = monthly EAR = 4.5%/12 = 0.00375 n = no.of months = 4 years x 12 = 48 12.19 = P + P x {[1 - (1+0.00375)^-(48-1)]/0.00375} 12.19 = P + P x 43.01739 12.19 = 44.01739P P = $0.28 million Monthly payment = $2,77,025.54
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.