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 Dodge City Cowboys; last year, he was the first runner$-$up for the Minor League Player of the Year award. Using his $93mph$ fastball, an impeccable curve ball and slider, and a reliable changeup pitch, he achieved a $15-2$ win$-$loss record, an earned run average $($ERA$)$ of $2\mathrm{.}76,$ and $123$ strikeouts in $99\mathrm{.}1$ 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, Noah Never$-$Enough, indicating that he is being called up to the Mobile Bayhoppers, the Cowboys's corresponding Major League Baseball $($MLB$)$ team. Moreover, Nick's contract is being revised to reflect his new status. The email describes the general termos and conditions of Nick's revised contract.

From: Noah Never$-$Enough

To: Nick Nohitter

Subject: New Team, New Contract Proposal

Nick,

Conqratulations! You've been called up to the Mobile Bayhoppers. Below are the

Nick is so excited! According to Noah, the contract is worth $$2,722,400-$assuming 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 Noah's calculations. After an extended conversation about what heII do with his newfound wealth, you and Nick have agreed that any funds received could be invested to earn $8\mathrm{.}00\%,$ 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.

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.

Nick Nohitter's Contract Evaluation Worksheet

A

B

C

D

E

F

$6$

$7$ Salary and Bonus

Year $1$

Year $2$

Year $3$

Year $4$

Total value

Cell B$5$ above$)$

$23$ Discounted Performance

Bonus

Given your worksheet calculations, which of the following statements is accurate? Is Noah's estimate of the value of Nick's contract accurate on either a nominal or discounted basis? Check all that apply.

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.

Noah's estimate of the nominal value of Nick's contract is correct.

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.

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 $8\mathrm{.}4328.]$

$$

$$

$$

Cell B$5$ above$)$

$23$ Discounted Performance

Bonus

$24$

$25$ Monthly Endorsement

Contract Payment

$26$ Discount fa