In his senior year at a major Midwestern university, William Sterns had been the second runner up

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Question:

In his senior year at a major Midwestern university, William Sterns had been the second runner up for the famed Heismann Tophy. The trophy goes to the outstanding football player in America and is presented annually by the New York Athletic Club. During the past football season, Sterns had run for over 1,500 yards and scored 18 touchdowns. He also caught 41 passes coming out of the backfield. His time in running the 40-yard dash, which professional scouts consider to be extremely important, was 4.38 seconds. He was voted first team All American by the Associated Press and was a second team All American in the Coaches Poll selections.

On Monday morning, his agent, John Pardy, called to say that he was looking at three different proposals that a major professional football team had made for Sterns services. The team had drafted him in the first round of the National Football League draft as the sixth player to be selected out of the thousands of college football players that were eligible for that year. The Edmonton, Alberta, team of the Canadian Football League was also interested in Wilson’s services. The Canadian team had called his agent over the weekend to put its offer on the table. While the National Football League (NFL) team that had drafted Sterns in the first round had exclusive rights overall other U.S. teams in signing Sterns during the current year, the Canadian team was not bound by such an arrangement and could make any offer it wished and hope the outcome would be positive.

Actual Proposals:

The NFL team offered the following three proposals. The team’s general manager, who was in charge of contract negotiations, said his team would stand behind any of the three offers and it was up to Sterns and his agent to choose which they preferred.

Please go through the valuations for each of the Contract options. Make sure that you show all of your work for each of the offers. Also clearly state which offer you would suggest that Sterns take including a full explanation as to why you support that offer and does your opinion change with a difference in the discount rate.

Contract offer 1:

$900,000 immediate signing bonus
$850,000 at the end of each year for the next five (5 years)

Contract offer 2:

$200,000 immediate signing bonus
$100,000 at the end of each year for the next four years.
$150,000 a year at the end of years 5 through 10
$1,000,000 a year at the end of years 11 through year 40.

Contract offer 3:

$1,000,000 immediate signing bonus
$500,000 at the end of year 1
$1,000,000 at the end of year 2
$1,500,000 at the end of year 3
$2,000,000 at the end of year 4

Canadian Football League:

$1,100,000 immediate signing bonus
$2,000,000 at the end of each year for the next three years.

Required Assignment

1. Calculate the present value of the four (4) contract proposals.

2. Which of the four contracts has the highest present value, and what is that amount?

Assume that the cash flows will be discounted using a 10 percent interest rate.

3. If the discount rate used was 7 percent instead of 10 percent, how might that change your answer? Would the resulting present values you calculated in #2 above be higher or lower – explain your answer.

4. Given your answers to #2, how much could Sterns pay himself for the next 40 years assuming a 10% interest rate? Calculate the answer using all four (4) football contracts.