Mike Carp is a star player for the Los Angeles Halos. His current contract calls for him to be paid $20 million today with nine additional annual payments of $20 million. In order to create room under the league's salary cap the team has proposed restructuring his contract by paying him over 19 years. They are offering him an upfront payment of $8,435,331.60 instead of the $20 million, but that payment will increase by 4% a year to cover expected inflation.
Required:
Prepare an Excel spreadsheet to answer the following questions. In order to receive full credit for the assignment, you must attach a copy of your Excel spreadsheet printed with the formulas showing (use the "Show Formulas" option).
1. In parallel columns, show the annual payments Carp will receive from the both the original contract and the restructured contract and calculate the total payments to be received under the both option. Use the formula for the future value of an annuity to calculate the payments under the restructured contract. Display all of your values in dollars i.e., no cents.
2. Based on these numbers should Carp restructure his contract?
3. Assuming a discount rate of 2%, determine the present value of the two options. Which option should Carp choose? Why? (Excel has many built in functions. Use the "NPV" function to help solve this question and the following question.)
4. Repeat Question #3 using discount rates of 4% and 8%?
5. Based on the evidence you have generated, explain the conditions under with Carp should accept the restructured contract.