Michael received a professional baseball contract paying $7,000,000 fo

Michael received a professional baseball contract paying $7,000,000 for 5 years, Bert received a two-year contract for $16,000,000 per year. For purposes of calculations, treat these contracts as ordinary annuities.

What are the present values of each contract if we assume a discount rate of 6%? It is not clear that the higher present value is the preferred contract in this situation. What other factors might you consider when determining which contract has greater value?

ANSWER

Bert = $29,334,283, Michael = $29,486,547. What happens to Bert in years 3,4, and 5? If he makes no more money than this is a fair comparison, but if he continues to play professional ball at a high level, then he can expect a fair amount of money in the subsequent three years. Later we will see how financial managers make comparisons such as this.