When Alex Rodriguez moved to the Texas Rangers in 2001, he received a lot of attention for his
"$ 252$252
million" contract (the total of the payments promised was
$ 252$252
million). He later moved to the Yankees, but assume the following in order to determine the value of his contract when he signed it:
Rodriguez earns
$ 16$16
million in the first year,
$ 17$17
million in years 2 through 4,
$ 19$19
million in years 5 and 6,
$ 23$23
million in year 7, and
$ 27$27
million in years 8 through 10. He also receives his
$ 10$10
million signing bonus spread equally over the first 5 years
($ 2$2
million per year). His deferred payments begin in 2011. The deferred pay- ment amounts total
$ 33$33
million and are
$ 5$5
million, then
$ 4$4
million, then eight amounts of
$ 3$3
million (ending in 2020). However, the actual payouts will be different. All of the deferred payments will earn
3 %3%
per year until they are paid. For example, the
$ 5$5
million is deferred from 2001 to 2011, or 10 years, meaning that it will actually be
$ 6.7196$6.7196
million when paid. Assume that the
$ 4$4
million payment deferred to 2012 is deferred from 2002 (each payment is deferred 10 years).
The contract is a 10-year contract, but each year has a deferred component so that cash flows are paid out over a total of 20 years. The contractual payments, signing bonus, and deferred components are given below. Note that, by contract, the deferred components are not paid in the year they are earned, but instead are paid (plus interest) 10 years later.
When Alex Rodriguez moved to the Texas Rangers in 2001, he received a lot of attention for his "S252 million contract (the total of the payments promised was $252 million). He later moved to the Yankees, but assume the following in order to determine the value of his contract when he signed it: Rodriguez earns $16 million in the first year, S17 million in years 2 through 4, S19 million in years 5 and 6, $23 million in year 7, and $27 million in years 8 through 10. He also receives his $10 million signing bonus spread equally over the first 5 years ($2 million per year. His deferred payments begin in 2011. The deferred payment amounts total $33 million and are $5 million, then $4 million, then eight amounts of $3 million (ending in 2020). However, the actual payouts will be different. All of the deferred payments will earn 3% per year until they are paid. For example, the $5 million is deferred from 2001 to 2011, or 10 years, meaning that it will actually be $6.7196 million when paid. Assume that the S4 million payment deferred to 2012 is deferred from 2002 (each payment is deferred 10 years). The contract is a 10-year contract, but each year has a deferred component so that cash flows are paid out over a total of 20 years. The contractual payments, signing bonus, and deferred components are given below. Note that, by contract, the deferred components are not paid in the year they are earned, but instead are paid (plus interest) 10 years later. 2006 $19 M 2002 $17 M $2 M 2012 2003 $17 M $2 M 2013 2004 $17 M $2M 2014 2001 S16 M $2 M 2011 Deferred SS M 2005 $19 M $2 M 2015 2007 $23M 2008 $27M 2009 $27M 2010 S27 M 2016 2017 2018 2019 2020 $4 M S3 M S3 M S3M $3 M $3 M $3 M $3 M S3 M Assume that an appropriate discount rate for A-Rod to apply to the contract payments is 7% per year. a. Calculate the true promised payments under this contract, including the deferred payments with interest. b. Draw a timeline of all of the payments. c. Calculate the present value of the contract. d. Compare the present value of the contract to the quoted value of $252 million. What explains the difference? a. Calculate the true promised payments under this contract, including the deferred payments with interest. The true promised payments under this contract for years 1 through 5 are: (Round all values to the nearest integer.) Year 1:5 Year 2:5 Year 3: 5 Year 4: S Year 5.5 million million million. million. million The true promised payments under this contract for years 6 through 10 are: (Round all values to the nearest million.) Year 6: 5 million Year 7: 5 million Year 8: 5 million Year 9: 8 million Year 10:50 million. The true promised payments under this contract for years 11 through 20 are: (Round all values to four decimal places.) Year 11: S million Year 12: 5 million Years 13 to 20: 5 million. b. Draw a timeline of all of the payments. The timeline of all the payments is shown below (cash flows in millions): (Select the best choice below.) O A Year 1 2 3 4 5 6 7 8 9 10 11 12 13 20 Cash Flows 518 OB. Year 1 519 519 2 3 519 4 521 519 5 6 523 7 523 8 527 9 $27 $6.72 55.38 $4.03 10 11 12 13 $4.03 20 Cash Flows $18 Year 1 $19 2 919 3 919 4 919 5 $21 6 $23 7 S27 8 527 9 $27 56.72 55.38 $4.03 10 11 12 13 $4.03 20 OG Cash Flows $18 OD. Year 1 $18 2 919 3 519 4 521 519 523 527 5 6 7 8 527 9 $27 $8.72 55.38 $4.03 10 11 12 13 $4.03 20 Cash Flows $18 519 519 519 521 519 523 527 527 $27 6.72 55.38 $4.03 $4.03 c. Calculate the present value of the contract. The present value of the contract is million (Round to the nearest million.) d. Compare the present value of the contract to the quoted value of $252 million. What explains the difference? (Select the best choice below.) O A The reason for the difference is although the $252 million quoted value does discount the future cash flows, it does not adjust the deferred payments for accrued interest. OB. The reason for the difference is the $252 million quoted value does not discount the future cash flows or adjust deferred payments for accrued interest. OC. The reason for the difference is although the $252 million quoted value does adjust the deferred payments for accrued interest, it does not discount the future cash flows. O D. The reason for the difference is that the contract was quoted incorrectly. When Alex Rodriguez moved to the Texas Rangers in 2001, he received a lot of attention for his "S252 million contract (the total of the payments promised was $252 million). He later moved to the Yankees, but assume the following in order to determine the value of his contract when he signed it: Rodriguez earns $16 million in the first year, S17 million in years 2 through 4, S19 million in years 5 and 6, $23 million in year 7, and $27 million in years 8 through 10. He also receives his $10 million signing bonus spread equally over the first 5 years ($2 million per year. His deferred payments begin in 2011. The deferred payment amounts total $33 million and are $5 million, then $4 million, then eight amounts of $3 million (ending in 2020). However, the actual payouts will be different. All of the deferred payments will earn 3% per year until they are paid. For example, the $5 million is deferred from 2001 to 2011, or 10 years, meaning that it will actually be $6.7196 million when paid. Assume that the S4 million payment deferred to 2012 is deferred from 2002 (each payment is deferred 10 years). The contract is a 10-year contract, but each year has a deferred component so that cash flows are paid out over a total of 20 years. The contractual payments, signing bonus, and deferred components are given below. Note that, by contract, the deferred components are not paid in the year they are earned, but instead are paid (plus interest) 10 years later. 2006 $19 M 2002 $17 M $2 M 2012 2003 $17 M $2 M 2013 2004 $17 M $2M 2014 2001 S16 M $2 M 2011 Deferred SS M 2005 $19 M $2 M 2015 2007 $23M 2008 $27M 2009 $27M 2010 S27 M 2016 2017 2018 2019 2020 $4 M S3 M S3 M S3M $3 M $3 M $3 M $3 M S3 M Assume that an appropriate discount rate for A-Rod to apply to the contract payments is 7% per year. a. Calculate the true promised payments under this contract, including the deferred payments with interest. b. Draw a timeline of all of the payments. c. Calculate the present value of the contract. d. Compare the present value of the contract to the quoted value of $252 million. What explains the difference? a. Calculate the true promised payments under this contract, including the deferred payments with interest. The true promised payments under this contract for years 1 through 5 are: (Round all values to the nearest integer.) Year 1:5 Year 2:5 Year 3: 5 Year 4: S Year 5.5 million million million. million. million The true promised payments under this contract for years 6 through 10 are: (Round all values to the nearest million.) Year 6: 5 million Year 7: 5 million Year 8: 5 million Year 9: 8 million Year 10:50 million. The true promised payments under this contract for years 11 through 20 are: (Round all values to four decimal places.) Year 11: S million Year 12: 5 million Years 13 to 20: 5 million. b. Draw a timeline of all of the payments. The timeline of all the payments is shown below (cash flows in millions): (Select the best choice below.) O A Year 1 2 3 4 5 6 7 8 9 10 11 12 13 20 Cash Flows 518 OB. Year 1 519 519 2 3 519 4 521 519 5 6 523 7 523 8 527 9 $27 $6.72 55.38 $4.03 10 11 12 13 $4.03 20 Cash Flows $18 Year 1 $19 2 919 3 919 4 919 5 $21 6 $23 7 S27 8 527 9 $27 56.72 55.38 $4.03 10 11 12 13 $4.03 20 OG Cash Flows $18 OD. Year 1 $18 2 919 3 519 4 521 519 523 527 5 6 7 8 527 9 $27 $8.72 55.38 $4.03 10 11 12 13 $4.03 20 Cash Flows $18 519 519 519 521 519 523 527 527 $27 6.72 55.38 $4.03 $4.03 c. Calculate the present value of the contract. The present value of the contract is million (Round to the nearest million.) d. Compare the present value of the contract to the quoted value of $252 million. What explains the difference? (Select the best choice below.) O A The reason for the difference is although the $252 million quoted value does discount the future cash flows, it does not adjust the deferred payments for accrued interest. OB. The reason for the difference is the $252 million quoted value does not discount the future cash flows or adjust deferred payments for accrued interest. OC. The reason for the difference is although the $252 million quoted value does adjust the deferred payments for accrued interest, it does not discount the future cash flows. O D. The reason for the difference is that the contract was quoted incorrectly
