Actual Proposals
The West Coast NFL team offered the following three proposals. The team's general manager,
who was in charge of contract negotiations, said his team would stand behind any of the three
offers and it was up to Billy Wilson and his agent to choose which they preferred.
Contract offer 1:
$900,000 immediate signing bonus.
$850,000 at the end of each year for the next five years.
Contract offer 2:
$200,000 immediate signing bonus.
$100,000 at the end of each year for the next four years.
$150,000 a year at the end of years 5 through 10.
$1,000,000 a year at the end of years 11 through year 40.
Contract offer 3:
$1,000,000 immediate signing bonus.
$500,000 at the end of year 1.
$1,000,000 at the end of year 2.
$1,500,000 at the end of year 3.
$2,500,000 at the end of year 4.
As part of the third offer, he was also promised a $200,000 bonus for any year in which he was
selected to play in the Pro Bowl All-Star game. His agent figured there was a 25 percent
probability of that occurring in each of the next four years.
The Edmonton, Alberta, team of the Canadian Football League offered the following:
$1,100,000 signing bonus.
$2,000,000 at the end of each year for the next three years.
The Canadian contract was not guaranteed. This means that Billy was assured of his signing
bonus, but if he did not make the team in any of the three years, he would not receive his salary.
His agent figured there was an 80 percent probability that his contract would be picked up (paid)
in each of next three years. (The U.S. team's contract proposals were all guaranteed.)
Wilsons Reaction
Billy Wilson was a sociology major in college and although he was red-shirted (laid out) for one
year, he would still receive his degree at the May graduation ceremonies. He was proud of the
2.75 average (out of 4.0 points) he had compiled because of the rigors of college football. He
knew that only about 40 percent of athletes on scholarship ever got their degree. At some
schools the average was as low as 10 percent, while Notre Dame boosted a graduation rate
approaching 100 percent.
As a nonbusiness major, Billy was confused about the process for determining the actual
numerical value of the offerings. For example, the second contract offer from the U.S. team had
a total dollar value of over $31 million. He was astounded by such a figure. He knew that
players selected as the very first player in the draft in prior years had not received such a high sum (Troy Aikman of the Dallas Cowboys had been paid $11 million in 1989 and Jeff George of the Indianapolis Colts $16 million in 1990). They had been the first players selected in the draft in their respective years, and he was only the sixth player chosen in the current year.
His agent, Joel Weinberg, began to explain to Billy the importance of the time value of money. He said inflows in the future were not worth nearly as much as current inflows and that, therefore, they should be discounted back to the present at a 10 percent interest rate. While Billy did not fully understand how the calculations were done, he knew he could rely on his agent to
do the proper analysis.
Required
1 . Calculate the present value of the three contract proposals offered by the U.S. team. Factor in any probability considerations where appropriate.
2. Calculate the present value of the contract offered by the Canadian team. Factor in any probability considerations where appropriate.
3. Which of the four contract offers has the highest present value? What is the amount?
4. If the discount rate used were 7 percent instead of 10 percent, how might that change your answer? You do not need to do new calculations, merely indicate what the likely impact would be.
5. Returning to your answer for question 3, assume Billy Wilson's agent will receive 10 percent of the present value of the contract as his fee. Also, the remaining 90 percent will be taxed at 33 percent. What is the after-tax value of the present value of the proceeds that Billy will receive?
6. If Billy and his agent think tax rates are likely to be higher in the future, how might that influence the decision?
7. Using the answer from question 3, how large an annuity could Billy Wilson pay himself for the next 40 years at 10 percent interest?
8.What other factors should Billy Wilson consider?