Poor Bobby Bonilla! The newspapers claim that he is making $5.7 million a year. He claims that this is not true in a present value sense and that he will really be making the following amounts for the next 5 years:

YearAmount

0 $ 5.5 million (Sign up Bonus)

1 $ 4 million

2$ 4 million

3$ 4 million

4$ 4 million

5$ 7 million

a.Assuming that Bonilla can make 7% on his investments, what is the present value of his contract?

b.If you wanted to raise the nominal value of his contract to $30 million, while preserving the present value, how would you do it? (You can adjust only the sign up bonus and the final year's cash flow.)

16. You are comparing houses in two towns in New Jersey. You have $100,000 to put as a down payment, and 30-year mortgage rates are at 8% -

ChathamSouth Orange

Price of the house$ 400,000 $ 300,000

Annual Property Tax$ 6,000 $ 12,000

The houses are roughly equivalent.

a. Estimate the total payments (mortgage and property taxes) you would have on each house. Which one is less expensive?

b. Are mortgage payments and property taxes directly comparable? Why or why not?

c. If property taxes are expected to grow 3% a year forever, which house is less expensive?

17. You bought a house a year ago for $250,000, borrowing $200,000 at 10% on a 30-year term-loan (with monthly payments). Interest rates have since come down to 9%. You can refinance your mortgage at this rate, with a closing cost that will be 3% of the loan. Your opportunity cost is 8%. Ignore tax effects.

a. How much are your monthly payments on your current loan (at 10%)?

b. How would your monthly payments be if you could refinance your mortgage at 9% (with a 30-year term loan)?

c. You plan to stay in this house for the next 5 years. Given the refinancing cost (3% of the loan), would you refinance this loan?

d. How much would interest rates have to go down before it would make sense to refinance this loan (assuming that you are going to stay in the house for five years)?