PV OF A CASH FLOW STREAM A rookie quarterback is negotiating his first NFL contract. His
As his adviser, which contract would you recommend that he accept?
To calculate: The best stream for present value of cash flow
Introduction:
Future Value of Cash Flow:
If single cash flow put in an investment today which pays us compound interest how much does it grow over the period of time is known as future value of cash flow.
Explanation of Solution
Calculation of present value of cash flow stream at 7% compounding rate
Contract 1 | Contract 2 | Contract 3 | ||||
Year | Cash in flow | Present Value | Cash in flow | Present Value | Cash in flow | Present Value |
1 | 3,000,000 | 2,803,738 | 2,000,000 | 1,869,159 | 7,000,000 | 6,542,056 |
2 | 3,000,000 | 2,620,316 | 3,000,000 | 2,620,316 | 1,000,000 | 873,439 |
3 | 3,000,000 | 2,448,894 | 4,500,000 | 3,673,340 | 1,000,000 | 816,298 |
4 | 3,000,000 | 2,288,686 | 5,500,000 | 4,195,924 | 1,000,000 | 762,895 |
Total PV | 10,161,634 | 12,358,739 | 8,994,688 |
Table (1)
Working Note for present value:
Present value for year 1 and contract 1
Present value for year 2 and contract 1
Present value for year 3 and contract 1
Present value for year 4 and contract 1
Present value for year 1 and contract 2
Present value for year 2 and contract 2
Formula to calculate present value for year 3 and contract 2
Formula to calculate present value for year 4 and contract 2
Formula to calculate present value for year 1 and contract 3
Formula to calculate present value for year 2 and contract 3
Formula to calculate present value for year 3 and contract 3
Formula to calculate present value for year 4 and contract 3
So, the contract 2 is the best option as total present value is highest for contract 2.
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Chapter 5 Solutions
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