16. Application of Time Value of Money Skills Saleem Swingman 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 Ketchum Baldies; last year, he was the first runner-up for the Minor League Player of the Year award. Using his 99 mph fastball, an impeccable curve ball and slider, and a reliable changeup pitch, he achieved a 18-2 win-loss record, an earned run average (ERA) of 2.23, and 166 strikeouts in 147.2 innings pitched. He is also your best friend. Two weeks ago, on his three-year anniversary with the team, Saleem received the following email from his agent, George Get-d'Bucks, indicating that he is being called up to the Springfield Dusties, the Baldies's corresponding Major League Baseball (MLB) team. Moreover, Saleem's contract is being revised to reflect his new status. The email describes the general terms and conditions of Saleem's revised contract. Saleem is so excited. According to George, the contract is worth $3,372,400-assuming receipt of all possible bonuses. After rereading the email twice and calling his family, Saleem called you to review the terms of the contract and verify George's calculations. After an extended conversation about what he'll do with his newfound wealth, you and Saleem have agreed that any funds received could be invested to earn 6.50%, 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. B D E F 1 2 3 96 Assumptions and Calculated Values Bank Rate Information: Saleem's Bank Account Rate (compounded monthly) Monthly Bank Rate Effective Annual Interest Rate 4 % 5 90 6 7 Year 1 Year 2 Year 3 Year 4 Total value Salary and Bonus Information: 8 $ $ S s 9 S $ Annual Salary (4% COLA) Monthly Salary Discount factor (based on Cell B4 above) S 10.8606 10 11.5880 10.1789 9.5400 13 s s 11 Discounted Annual Salary 12 Time-in-League Bonus 14 Discount factor (based on Cell Be above) 15 Discounted Time-in-League Bonus 0.9681 16 17 S S 18 0.9372 0.8784 0.8233 0.7716 Milestone Bonus Discount factor (based on Cell B5 above) Discounted Milestone Bonus 19 S 20 20 21 S S S 22 0.9372 0.8784 0.8233 0.7716 Performance Bonus Discount factor (based on Cell B5 above) Discounted Performance Bonus 23 S $ 24 $ 11.5880 10.8606 25 Monthly Endorsement Contract Payment 26 Discount factor (based on Cell B4 above) 27 Discounted Monthly Endorsement Payment 28 29 Contract's Total Nominal Value 30 Contract's Total Discounted Value s S 1. Given your worksheet calculations, which of the following statements is accurate? Is George's estimate of the value of Saleem's contract accurate on either a nominal or discounted basis? Check all that apply. 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. George's estimate of the value of Saleem's contract is incorrect on a nominal basis, and the error is $80,389. 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 Saleem's endorsement opportunity can earn 6% (compounded quarterly) on his deposited funds. She would have to deposits each quarter, starting exactly two years before the day Saleem 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.] 16. Application of Time Value of Money Skills Saleem Swingman 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 Ketchum Baldies; last year, he was the first runner-up for the Minor League Player of the Year award. Using his 99 mph fastball, an impeccable curve ball and slider, and a reliable changeup pitch, he achieved a 18-2 win-loss record, an earned run average (ERA) of 2.23, and 166 strikeouts in 147.2 innings pitched. He is also your best friend. Two weeks ago, on his three-year anniversary with the team, Saleem received the following email from his agent, George Get-d'Bucks, indicating that he is being called up to the Springfield Dusties, the Baldies's corresponding Major League Baseball (MLB) team. Moreover, Saleem's contract is being revised to reflect his new status. The email describes the general terms and conditions of Saleem's revised contract. Saleem is so excited. According to George, the contract is worth $3,372,400-assuming receipt of all possible bonuses. After rereading the email twice and calling his family, Saleem called you to review the terms of the contract and verify George's calculations. After an extended conversation about what he'll do with his newfound wealth, you and Saleem have agreed that any funds received could be invested to earn 6.50%, 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. B D E F 1 2 3 96 Assumptions and Calculated Values Bank Rate Information: Saleem's Bank Account Rate (compounded monthly) Monthly Bank Rate Effective Annual Interest Rate 4 % 5 90 6 7 Year 1 Year 2 Year 3 Year 4 Total value Salary and Bonus Information: 8 $ $ S s 9 S $ Annual Salary (4% COLA) Monthly Salary Discount factor (based on Cell B4 above) S 10.8606 10 11.5880 10.1789 9.5400 13 s s 11 Discounted Annual Salary 12 Time-in-League Bonus 14 Discount factor (based on Cell Be above) 15 Discounted Time-in-League Bonus 0.9681 16 17 S S 18 0.9372 0.8784 0.8233 0.7716 Milestone Bonus Discount factor (based on Cell B5 above) Discounted Milestone Bonus 19 S 20 20 21 S S S 22 0.9372 0.8784 0.8233 0.7716 Performance Bonus Discount factor (based on Cell B5 above) Discounted Performance Bonus 23 S $ 24 $ 11.5880 10.8606 25 Monthly Endorsement Contract Payment 26 Discount factor (based on Cell B4 above) 27 Discounted Monthly Endorsement Payment 28 29 Contract's Total Nominal Value 30 Contract's Total Discounted Value s S 1. Given your worksheet calculations, which of the following statements is accurate? Is George's estimate of the value of Saleem's contract accurate on either a nominal or discounted basis? Check all that apply. 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. George's estimate of the value of Saleem's contract is incorrect on a nominal basis, and the error is $80,389. 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 Saleem's endorsement opportunity can earn 6% (compounded quarterly) on his deposited funds. She would have to deposits each quarter, starting exactly two years before the day Saleem 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.]