Question

A famous quarterback just signed a $15 million contract providing $3 million a year for 5 years. A less famous receiver signed a $14 million 5-year contract providing $4 million now and $2 million a year for 5 years. Who is better paid? the interest rate is 10%.

Answer 1

When a stream of cash flows is paid or received during the whole time period, it is termed as annuity.

Present value of annuity is calculated with the help of the following formula:

Where,

C is the cash flow

r is required rate

n is the duration of payments

The famous Q receives $3 million every year for 5 years at 10% interest rate. It is required to compute the PV cash flows as shown below:

Therefore, the present value of money received by famous Q is.

The less famous one receives a cash flow of $4 million now and $2 million every year for 5 years at an interest rate of 10%, the PV of these cash flows will be:

Therefore, the present value of money received by less famous is.

After comparing the PV of the cash flows received by both the receivers, it can be seen that PV of cash flow received by less famous receiver of 11.58 million is more than that received by famous Q of $11.37 million. Therefore, less famous is better paid.