Chapter 5, Problem 20P

### Fundamentals of Financial Manageme...

15th Edition
Eugene F. Brigham + 1 other
ISBN: 9781337395250

Chapter
Section

### Fundamentals of Financial Manageme...

15th Edition
Eugene F. Brigham + 1 other
ISBN: 9781337395250
Textbook Problem

# PV OF A CASH FLOW STREAM A rookie quarterback is negotiating his first NFL contract. His opportunity cost is 7%. 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:As his adviser, which contract would you recommend that he accept?

Summary Introduction

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

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

Presentāvalueāfactor=CashāFlow(1+Interestārate)Numberāofāyears=$3,000,000(1+0.07)1=$3,000,0001.07=$2,803,738.3 Present value for year 2 and contract 1 Presentāvalueāfactor=CashāFlow(1+Interestārate)Numberāofāyears=$3,000,000(1+0.07)2=$2,620,316.1 Present value for year 3 and contract 1 Presentāvalueāfactor=CashāFlow(1+Interestārate)Numberāofāyears=$3,000,000(1+0.07)3=$2,448,893.6 Present value for year 4 and contract 1 Presentāvalueāfactor=CashāFlow(1+Interestārate)Numberāofāyears=$3,000,000(1+0.07)4=$2,288,685.6 Present value for year 1 and contract 2 Presentāvalueāfactor=CashāFlow(1+Interestārate)Numberāofāyears=$2,000,000(1+0.07)1=$1,869,158.8 Present value for year 2 and contract 2 Presentāvalueāfactor=CashāFlow(1+Interestārate)Numberāofāyears=$3,000,000(1+0

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