A player for a Rice team, Jim Jones, is graduating this year and is considering a career in professional sports. The alternative is to work for two years and then attend business school for two more years before taking a job in finance. The professional sports career involves an up-front signing bonus of $500,000 followed by guaranteed salaries over the next ten years of $750,000 per year (in real yearend values starting at the end of the first year). Assume that the professional sports career ends after 10 years, at which time Jim could expect to earn an income of $75,000 per year (in real terms) growing at 1 % per year for the next 30 years. The business career would involve earning $75,000 this year, $78,000 next year, and spending $30,000 per year for the following two years while attending business school (all amounts measured as end of year real values). Upon graduation, however, Jim could expect a starting salary of $140,000 (in year-end values) growing at 7.5% (in real terms) for the next 35 years.
(a) If the appropriate annual effective discount rate is 4.5%, show that the earnings stream associated with the professional sports career has the larger discounted present value.
(b) If Jim desires to maintain a constant level of annual consumption at a discount rate of 4.5%, what would his annual real consumption be?
(c) What financial assets should Jim have at the end of his first year of employment?
(d) How much should Jim have invested the year that he ceases being a professional athlete?