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Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977

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BuyFindarrow_forward

Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977
Textbook Problem

PV OF A CASH FLOW STREAM A rookie quarterback is negotiating his first NFL contract. His opportunity cost is 10%. He has been offered three possible 4-year contracts. Payments are guaranteed, and they would be made at the end of each year. Terms of each contract are as follows:

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As his adviser, which contract would you recommend that he accept?

Summary Introduction

To determine: The contract to be recommended.

Net Present Value (NPV):

The net present of a project can be defined as the difference between the present value of the project’s total cost and the present value of the free cash flows. It is not required to consider the information related to the cost of the project.

Therefore, the NPV would be negative when the project's cost is higher as compared to the present value of free cash flows. On the other hand, the NPV of the project would be positive when the cost of the project is lower as compared to the present value of the free cash flows.

Explanation

Calculate the NPV of the first contract.

Year Cash Flow PV factor at 10% Present value of cash flow
1 $3,000,000 0.9091 $2,727,300
2 $3,000,000 0.8264 $2,479,200
3 $3,000,000 0.7513 $2,253,900
4 $3,000,000 0.683 $2,049,300
Present value of cash outflows $9,509,400

Table 1

Calculate the NPV of the second contract.

Year Cash Flow PV factor at 10% Present value of cash flow
1 $2,000,000 0.9091 $1,818,200
2 $3,000,000 0...

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