7.4 According to the February 7, 1983, issue of The Sporting News, the Kansas City Royals’

designated hitter, Hal McRae, signed a three-year contract in January 1983 with the following provisions:

• $400,000 signing bonus.

• $250,000 salary per year for three years.

• 10 years of deferred payments of $125,000 per year (these payments begin in year 4).

• Several bonus provisions that total as much as $75,000 per year for the three years of the contract.

Assume that McRae has a 60-percent probability of receiving the bonuses each year, and that he signed the contract on January 1, 1983. (Hint: Use the expected bonuses as incremental cash flows.) Assume an effective annual interest rate of 12.36 percent, and ignore taxes. McRae’s salary and bonus are paid at the end of the year. What was the present value of this contract in January when McRae signed it?