Managerial Controls and Budgeting Problem - Capital Budgeting; Contract Evaluation
Great news!! Your boss heard about your outstanding work in the TMU MBA program and has decided that you are now an indispensable member of the management team. As an incentive to remain with the company, they have offered you a lucrative employment contract with the following compensation options:
Option 1: A 5 year, $20 million contract with a $4.5 million signing bonus and annual payments of $3.1 million. The deal also includes the exclusive use of a company car, a 1972 VW bug. Since this perk is "priceless", no value can be assigned to it.
Option 2: A 5 year, $23.5 million contract with increasing annual payments as shown below. The deal also includes the transfer of ownership of the company yacht in year five, at which point the value (which will be considered a balloon payment) will be $5 million (it's a really nice boat).
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Option 2 Payment Stream
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Year 1
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$ 3,875,000
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Year 2
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3,750,000
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Year 3
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3,650,000
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Year 4
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3,625,000
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Year 5
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3,600,000
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Year S Yacht (balloon)
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5,000,000
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Total
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$ 23,500,000
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Required:
1. Prepare a NPV analysis of each proposed contract option using a 10% required rate of return. Use the format provided on the answer sheet.
2. Indicate which contract option you have chosen to accept and explain your choice.