16. Application of Time Value of Money Skills Harry Hurler has been playing baseball since he was five years old and has always dreamed of playing in the big leagues. Last season, he was a starting pitcher for a double-A (AA)-level baseball team, the Yakima Hops; last year, he was the first runner-up for the Minor League Player of the Year award. Using his 96 mph fastball, an impeccable curve ball and slider, and a reliable changeup pitch, he achieved a 16-3 win-loss record, an earned run average (ERA) of 2.98, and 146 strikeouts in 117.0 innings pitched. He is also your best friend. Two weeks ago, on his three-year anniversary with the team, Harry received the following email from his agent, Noah Never Enough, indicating that he is being called up to the Boston Back Bay Boys, the Hops's corresponding Major League Baseball (MLB) team. Moreover, Harry's contract is being revised to reflect his new status. The email describes the general terms and conditions of Harry's revised contract. From: Noah Never-Enough To: Harry Hurler Subject: New Team, New Contract Proposal Harry, Congratulations! You've been called up to the Boston Back Bay Boys. Below are the offered terms and conditions of your new contract. After you review them and think about the offer, call me and we'll discuss your options. Congrats again! Harry is so excited! According to Noah, the contract is worth $2,998,400-assuming receipt of all possible bonuses. After rereading the email twice and calling his family, Harry called you to review the terms of the contract and verify Noah's calculations. After an extended conversation about what he'll do with his newfound wealth, you and Harry have agreed that any funds received could be invested to earn 8.00%, compounded monthly. Contract Evaluation Worksheet Complete the following worksheet by inserting the appropriate values to evaluate the contract and answer the related questions. Note: To clarify possible sources of confusion and simplify your calculations: Assume that all bonuses are earned in each of the years for which they are available and are paid at the end of the corresponding year(s), unless specifically stated differently. Their value should be based on the salary in effect at the time the bonuses were earned. The endorsement proceeds are paid in accordance with the terms of the deal. Remember that the timing of a cash flow affects the interest rate that is used to discount the cash flow. For example, annual interest rates should be used to discount annual cash flows, and monthly interest rates are used to discount monthly cash flows. Therefore, it may be necessary to compute the appropriate interest rate that should be used in a discounting calculation. Round all dollar amounts to the nearest whole dollar and carry out all interest rate factors to four decimal places. When entering intermediate values as answer choices, be sure to round them to the nearest dollar, however when using those same values to calculate another answer, do not round. A B D E % 1 Assumptions and Calculated Values 2 Bank Rate Information: 3 Harry's Bank Account Rate (compounded monthly) 4 Monthly Bank Rate 5 Effective Annual Interest Rate % % 6 7 Year 1 Year 2 Year 3 Year 4 Total value $ Is 11.4958 10.6148 9.8013 9.0501 Salary and Bonus Information: 8 Annual Salary (4% COLA) ( 9 Monthly Salary 10 Discount factor (based on Cell B4 above) 11 Discounted Annual Salary 12 13 Time-in-League Bonus 14 Discount factor (based on Cell B4 above) 15 Discounted Time-in-League Bonus 16 17 Milestone Bonus 18 Discount factor (based on Cell B5 above) 19 Discounted Milestone Bonus 0.9609 S S 0.9234 0.8526 0.7873 0.7269 20 21 Performance Bonus 0.9234 0.8526 0.7873 0.7269 22 Discount factor (based on Cell B5 above) 23 Discounted Performance Bonus 24 25 Monthly Endorsement Contract Payment 26 Discount factor (based on Cell B4 above) 27 Discounted Monthly Endorsement Payment 11.4958 10.6148 $ $ 28 29 Contract's Total Nominal Value 30 Contract's Total Discounted Value 1. Given your worksheet calculations, which of the following statements is accurate? Is Noah's estimate of the value of Harry's contract accurate on either a nominal or discounted basis? Check all that apply. Noah's estimate of the value of Harry's contract is incorrect on a nominal basis, and the error is $33,663. It is appropriate and necessary to discount the performance bonus using the bank account's effective annual interest rate because of differences in the timing of the compounding of the bank account and that of the payments for the performance bonus. It is appropriate and necessary to discount the endorsement contract using the bank account's effective annual interest rate because of differences in the timing of the compounding of the bank account and that of the payments on the endorsement contract. Related Question: The local car dealer creating Harry's endorsement opportunity can earn 6% (compounded quarterly) on his deposited funds. She would have to deposit $ each quarter, starting exactly two years before the day Harry signs his contract, to fund her endorsement contract. [Note: The future value interest factor of 6% compounded quarterly for eight quarterly periods is 8.4328.]