Because of a salary cap, National Basketball
Association teams are not allowed to exceed a certain annual limit in total player
salaries. Suppose the Toronto Raptors had scheduled salaries exactly equal to
their cap of $16 million for 2006. A star player was scheduled to receive $3 million
in 2006. To free up money to pay a prize rookie, the star player agreed to defer $1 million of his salary for two years, by which time the salary cap will have
been increased. His contract called for salary payments of $3 million in 2006,
$3.5 million in 2007, and $4 million in 2008. Now he will receive $2 million in
2006, still $3.5 million in 2007, and $5 million in 2008. For simplicity, assume
that all salaries are paid.on July 1 of the year they are scheduled. The star’s minimum
desired rate of return is 12 percent.
Did the deferral of salary cost the star anything? If so, how much? Compute
the present value of the sacrifice on July 1, 2006. Explain your findings.