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16. Application of Time Value of Money Skills Colin Closer 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 bascball team, the Moab Mountain Goats; last year, he was the first runner-up for the Minor League Player of the Year award. Using his 97mph fastball, an impeccable curve ball and slider, and a reliable changeup piteh, he achieved a 173 win-loss record, an earned run average (ERA) of 2.84 , and 108 strikeouts in 123.1 innings pitched. He is also your best friend. Two weeks ago, on his three-year anniversary with the team, Colin received the following email from his agent, Michael Make-dTeam, indicating that he is being called up to the Moblle Bayhoppers, the Mountain Goats's corresponding Major League Baseball (MLB) team. Moreover, Colin's contract is being revised to reflect his new status. The email describes the general terms and conditions of Colin's revised contract. - Colin Closer hereafter referred to as the "Player," is offered a four-year contract with an annual salary of $504,000 per year, to be paid at the end of each month in the contract term. - Under the league's collective bargaining agreement, the Player will receive a 4% cost-of-living adjustment (COLA) to his annual satary at the beginning of every other year. This means that the Player's annual salary will increase at the beginning of year 2 and year 4 , as applicable. - In addition, the Player will receive a one-time $15,000 time-in-league bonus after six months of participation with an MLB team. This bonus will be paid immediately on completion of the six-month period. - The Player is offered a performance-based bonus, as well as a milestone bonus. Both are intended to encourage outstanding performance. - The player is offered the following award-based performance incentive: a 15% bonus payable ot the end of the operating year if he is selected to play in the All-Star game. The Player is also offered the following milestone bonus: a $125,000 bonus if he ties Nolan Ryan's 1973 single-season strikeout record (383 strikeouts). - The Player is eligible for each potential bonus each year that the contract is in effect and, if expressed as a percentage, will be based on the value of the Player's base annual salary for the corresponding year. If earned, the performance and milestone bonuses will be distributed in a single payment at the beginning of the next controct year, Athough this proposal describes only one milestone, the actual contract contains several progressive milestones. Exceeding one milestone creates the opportunity to exceed another. Colin is 50 excited According to Michael, the contract is worth $2,878,400-assuming receipt of all possible bonuses. After rereading the emalt twice and catling his fomily, Colin colled you to review the terms of the contract and verify Michael's calculations. After an extended comversation about what. Colin is so excited According to Michael, the contract is worth $2,878,400-assuming receipt of all possible bonuses. After rereading the email twice and calling his family, Colin called you to review the terms of the contract and verify Michael's calculations. After an extended conversation about what heil do with his newfound wealth, you and Colin have agreed that any funds received could be invested to earn 9.00%, 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 carned. - 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 fow. For example, annual interest rates should be used to discount annual cash flows, and monthly interest rates are used to discount monthly cash fows. 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 cholces, be sure to round them to the nearest dollar, however when using those same values to calculate another answer, do not round. Colin Closer's Contract Evaluation Worksheet A B c D E F 1 Assumptions and Calculated Values 2. Bank Rate Information: 3 Colin's Bank Account Rate (compounded monthly) 4 Monthly Bank Rate 5 Effective Annual Interest Rate 6 7 Salary and Bonus Information: Year 1 Year 3 Year 4 Total value 8 Annual Salary (4\% COLA) 9 Monthly Salary 10 Discount factor (based on Cell Bs 11.434912673 10.4542 .3346 9.557659114 B.737976633897 above) 11 Discounted Annual Salary 5 12 13 Time-in-League Banus 14 Discount factor (based on Cell BA 3 above) 15 Discounted Time-in-League Bonus 16 17 Milestone Bonus 16 Discount factor cbased on Cell BS 0.9562 above) 19 Discounted Milestone Bonus 20 21 Performance Bonus 1. s 5 1. Given your worksheet calculations, which of the following statements is accurate? is Michael's estimate of the value of Colin'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. 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. Michael's estimate of the value of Colin's contract is incorrect on a nominal basis, and the error is $48,663. Related Question: The local car dealer creating Colin's endorsement opportunity can earn 5% (compounded quarterty) on his deposited funds. She would have to deposit each quarter, starting exactly two years before the day Colin signs his contract, to fund her endorsement contract. [Note: The future value interest factor of 6% compounded quarteriy for eight quarteriy periods is 8.4328. ] 16. Application of Time Value of Money Skills Colin Closer 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 bascball team, the Moab Mountain Goats; last year, he was the first runner-up for the Minor League Player of the Year award. Using his 97mph fastball, an impeccable curve ball and slider, and a reliable changeup piteh, he achieved a 173 win-loss record, an earned run average (ERA) of 2.84 , and 108 strikeouts in 123.1 innings pitched. He is also your best friend. Two weeks ago, on his three-year anniversary with the team, Colin received the following email from his agent, Michael Make-dTeam, indicating that he is being called up to the Moblle Bayhoppers, the Mountain Goats's corresponding Major League Baseball (MLB) team. Moreover, Colin's contract is being revised to reflect his new status. The email describes the general terms and conditions of Colin's revised contract. - Colin Closer hereafter referred to as the "Player," is offered a four-year contract with an annual salary of $504,000 per year, to be paid at the end of each month in the contract term. - Under the league's collective bargaining agreement, the Player will receive a 4% cost-of-living adjustment (COLA) to his annual satary at the beginning of every other year. This means that the Player's annual salary will increase at the beginning of year 2 and year 4 , as applicable. - In addition, the Player will receive a one-time $15,000 time-in-league bonus after six months of participation with an MLB team. This bonus will be paid immediately on completion of the six-month period. - The Player is offered a performance-based bonus, as well as a milestone bonus. Both are intended to encourage outstanding performance. - The player is offered the following award-based performance incentive: a 15% bonus payable ot the end of the operating year if he is selected to play in the All-Star game. The Player is also offered the following milestone bonus: a $125,000 bonus if he ties Nolan Ryan's 1973 single-season strikeout record (383 strikeouts). - The Player is eligible for each potential bonus each year that the contract is in effect and, if expressed as a percentage, will be based on the value of the Player's base annual salary for the corresponding year. If earned, the performance and milestone bonuses will be distributed in a single payment at the beginning of the next controct year, Athough this proposal describes only one milestone, the actual contract contains several progressive milestones. Exceeding one milestone creates the opportunity to exceed another. Colin is 50 excited According to Michael, the contract is worth $2,878,400-assuming receipt of all possible bonuses. After rereading the emalt twice and catling his fomily, Colin colled you to review the terms of the contract and verify Michael's calculations. After an extended comversation about what. Colin is so excited According to Michael, the contract is worth $2,878,400-assuming receipt of all possible bonuses. After rereading the email twice and calling his family, Colin called you to review the terms of the contract and verify Michael's calculations. After an extended conversation about what heil do with his newfound wealth, you and Colin have agreed that any funds received could be invested to earn 9.00%, 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 carned. - 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 fow. For example, annual interest rates should be used to discount annual cash flows, and monthly interest rates are used to discount monthly cash fows. 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 cholces, be sure to round them to the nearest dollar, however when using those same values to calculate another answer, do not round. Colin Closer's Contract Evaluation Worksheet A B c D E F 1 Assumptions and Calculated Values 2. Bank Rate Information: 3 Colin's Bank Account Rate (compounded monthly) 4 Monthly Bank Rate 5 Effective Annual Interest Rate 6 7 Salary and Bonus Information: Year 1 Year 3 Year 4 Total value 8 Annual Salary (4\% COLA) 9 Monthly Salary 10 Discount factor (based on Cell Bs 11.434912673 10.4542 .3346 9.557659114 B.737976633897 above) 11 Discounted Annual Salary 5 12 13 Time-in-League Banus 14 Discount factor (based on Cell BA 3 above) 15 Discounted Time-in-League Bonus 16 17 Milestone Bonus 16 Discount factor cbased on Cell BS 0.9562 above) 19 Discounted Milestone Bonus 20 21 Performance Bonus 1. s 5 1. Given your worksheet calculations, which of the following statements is accurate? is Michael's estimate of the value of Colin'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. 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. Michael's estimate of the value of Colin's contract is incorrect on a nominal basis, and the error is $48,663. Related Question: The local car dealer creating Colin's endorsement opportunity can earn 5% (compounded quarterty) on his deposited funds. She would have to deposit each quarter, starting exactly two years before the day Colin signs his contract, to fund her endorsement contract. [Note: The future value interest factor of 6% compounded quarteriy for eight quarteriy periods is 8.4328. ]
