The Hazards, a professional baseball team, want to sign pitcher Alex McScoob to a two-year contract but, because of salary cap limitations, can only pay $8 million for the ﬁrst year (Alex's
Market value is $10 million per year). The Hazards offer to pay $8 million in year 1 and $13 million in
Year 2. Should Alex sign the contract?
A) Yes, Alex is better off ﬁnancially regardless of the interest rate.
B) Yes, if the interest rate is less than 50 percent.
C) Yes, but only if the team expects to be successful.
D) Yes, but only if the interest rate is less than 10 percent.

Question

Quizplus · Accepted Answer

The contract's total value is $21 million over two years, which averages to $10.5 million per year, exceeding Alex's market value of $10 million per year. However, the present value of the contract depends on the interest rate. If the interest rate is less than 50%, the present value of the second year's $13 million, when discounted back to the present, combined with the first year's $8 million, would still be advantageous for Alex compared to his market value.

The Hazards, a Professional Baseball Team, Want to Sign Pitcher