Question
16. Application of Time Value of Money Skills Nick Nohitter has been playing baseball since he was five years old and has always dreamed of
16. Application of Time Value of Money Skills
Nick Nohitter 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 Roswell Extraterrestrials; last year, he was the first runner-up for the Minor League Player of the Year award. Using his 93 mph fastball, an impeccable curve ball and slider, and a reliable changeup pitch, he achieved a 15-2 winloss record, an earned run average (ERA) of 2.76, and 123 strikeouts in 99.1 innings pitched. He is also your best friend.
Two weeks ago, on his three-year anniversary with the team, Nick received the following email from his agent, Michael Make-dTeam, indicating that he is being called up to the Springfield Dusties, the Extraterrestrialss corresponding Major League Baseball (MLB) team. Moreover, Nicks contract is being revised to reflect his new status. The email describes the general terms and conditions of Nicks revised contract.
From: Michael Make-dTeam
To: Nick Nohitter
Subject: New Team, New Contract Proposal
Nick,
Congratulations! Youve been called up to the Springfield Dusties. Below are the offered terms and conditions of your new contract. After you review them and think about the offer, call me and well discuss your options. Congrats again!
Salary and Incentives:
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In addition to the proposal offered by the Dusties, Ive also been able to secure the following endorsement opportunity:
A local car dealer has offered you a contract that will pay $750 per month for two years. This contract is contingent on your accepting the contract with the Dusties and will take effect immediately upon signing your MLB contract. In return for these payments, you will participate in the dealers promotional events, such as signing autographs and allowing photographs as requested.
Ive also attached a worksheet that you can use to analyze the deal. Im in negotiations for the rest of the day, so lets discuss your thoughts on the contract proposal tomorrow. Im proud of you!
Take care,
Michael
Michael Make-dTeam
Sports Agent, R&R Talent Management Inc. | Springfield
Nick is so excited! According to Michael, the contract is worth $3,260,400assuming receipt of all possible bonuses. After rereading the email twice and calling his family, Nick called you to review the terms of the contract and verify Michaels calculations. After an extended conversation about what hell do with his newfound wealth, you and Nick have agreed that any funds received could be invested to earn 6.00%, 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:
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Nick Nohitter's Contract Evaluation Worksheet
A | B | C | D | E | F | |
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1 | Assumptions and Calculated Values | |||||
2 | Bank Rate Information: | |||||
3 | Nick's Bank Account Rate (compounded monthly) | % | ||||
4 | Monthly Bank Rate | % | ||||
5 | Effective Annual Interest Rate | % | ||||
6 | ||||||
7 | Salary and Bonus Information: | Year 1 | Year 2 | Year 3 | Year 4 | Total value |
8 | Annual Salary (4% COLA) |
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9 | Monthly Salary |
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10 | Discount factor (based on Cell B4 above) | 11.6189 | 10.9439 | 10.3082 | 9.7093 | |
11 | Discounted Annual Salary |
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12 | ||||||
13 | Time-in-League Bonus |
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14 | Discount factor (based on Cell B4 above) | 0.9705 | ||||
15 | Discounted Time-in-League Bonus |
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16 | ||||||
17 | Milestone Bonus |
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18 | Discount factor (based on Cell B5 above) | 0.9419 | 0.8872 | 0.8356 | 0.7871 | |
19 | Discounted Milestone Bonus |
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20 | ||||||
21 | Performance Bonus |
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22 | Discount factor (based on Cell B5 above) | 0.9419 | 0.8872 | 0.8356 | 0.7871 | |
23 | Discounted Performance Bonus |
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24 | ||||||
25 | Monthly Endorsement Contract Payment |
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26 | Discount factor (based on Cell B4 above) | 11.6189 | 10.9439 | |||
27 | Discounted Monthly Endorsement Payment |
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28 | ||||||
29 | Contracts Total Nominal Value |
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30 | Contracts Total Discounted Value |
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1. Given your worksheet calculations, which of the following statements is accurate? Is Michaels estimate of the value of Nicks contract accurate on either a nominal or discounted basis? Check all that apply.
Michaels estimate of the nominal value of Nicks contract is correct.
Michaels estimate of the value of Nicks contract is incorrect on a nominal basis, and the error is $28,088.
It is appropriate and necessary to discount the performance bonus using the bank accounts 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.
Related Question: The local car dealer creating Nick'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 Nick 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.]
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