1. Application of Time Value of Money Skills Aa Aa As the son of a Major League Baseball (MLB) player, Henry Homerun-King has been playing baseball since he was old enough to hold a bat, and he has always dreamed of following in his father's footsteps. For the past four years, he's been the starting center fielder for the Moab Mountain Goats, a double-A (AA)-level baseball team. Last year, based on his outstanding fielding and hitting record, including 124 runs batted in (RBI) and 27 home runs, he was selected to receive the Minor League Player of the Year award Yesterday, in a telephone conversation with his agent, Michael Make-dTeam, Henry learned that he's being called up to the big leagues and traded to the Mobile Bayhoppers! In fact, he's supposed to report to the coach of the Bayhoppers next Monday. To add another source of change to his world, Henry and Michael must negotiate a new contract with Alex Jordan, the general manager of the Bayhoppers Henry and Michael are having a prenegotiation conversation Michael Henry, we need to review and agree on the numbers and provisions that I'm going to propose to Alex later this afternoon Henry Cool! I am so excited! I checked the league standings this morning, and the Bayhoppers are currently in second place in the league. My dad said that they are on fire so far this season, and if they can continue their current level of performance, they-no, I mean we-could qualify for the playoffs by mid-September. Wouldn't that be incredible? Michael Yeah, kid, it would. But let's focus on today's contract negotiations. I want your input, so let's run down my list of thoughts, and then we carn talk about your move and your transition to Mobile Henry Ok, what's on your list? Michael First, I'm proposing a three-year salary equal to 15% greater than the MLB's minimum player salary of $414,000. This should bring your annual salary to $476,100 per year for each of the next three years. My rationale is that if you do really well during the next three years, then we can renegotiate your contract sooner and go for the really big bucks in three-rather than in four or five-years Remember that you will be paid at the end of each month, and don't worry about the effect of taxes at this stage of the deal. We'll worry about your federal and state taxes once we meet with your financial planner So now, let's think about the other terms of your contract. I'm thinking that we propose an allowance of $7,500 to pay for your moving expenses, to be paid when the contract is signed, a signing bonus of $15,000, and a performance bonus. I've also lined up your first endorsement contract for you Henry Great! But two quick questions. First, when would the signing bonus be paid? Second, what type of performance bonus are you thinking about? Michael In the case of the signing bonus, I think, given your ability to manage money, we should ask that you receive one-third of the bonus at the beginning of each year of your contract. I think we capitalize on your fielding and batting performance last year and ask for a 15% bonus payable if you are selected to play in the All-Star game. Oh, and don't forget, you're also eligible for a $10,000 time-in-league bonus if you remain on the roster for six months. This bonus is usually paid at the end of the first year of your contract. The last important detail is the endorsement deal that I've found for you. A restaurant owner in Mobile will pay you $200 per month to spend a maximum of six hours per month meeting and greeting her guests on nongame nights. In return for your payments-and a free meal on the nights you appear-you will sign autographs and have your picture taken with guests. As of today, the restaurant owner is only willing to commit to a one-year contract Henry That sounds good. But how much is all this going to add up to? It sounds like an awful lot of money, so what am I going to do with it all? Spend it? Save and invest it? Michael As we discussed when you signed your contract with my firm, I have a financial advisor that's going to help you answer those questions. You have an appointment to talk with her tomorrow, but I think it is reasonable to assume that you can earn a 7.5000%, compounded monthly, on your funds during the term of your contract. In the meantime, I'll be talking with Alex Jordan to see how much of what I propose that the Bayhoppers are willing to pay How about if you spend some time computing how much money you're actually going to make-net of my commission and your taxes-if Alex accepts our proposal? Don't forget that your bonuses are taxed as ordinary income Henry Ok, I'll give it a try. I remember some of the time value of money techniques that I learned in my college finance class. Perhaps we can review my results after you've had your conversation with Mr. Jordan and we have a better idea of the contract numbers? Michael Henry, that sounds like an excellent plan. When we hang up, I'll email you a worksheet that you can use if you'd like Contract Evaluation Worksheet Complete the following worksheet by inserting the appropriate values to evaluate the contract and answer the related questions. Note: To clarify possible sources of confusion and simplify your calculations .Assume that all bonuses are earned in each of the years for which they are available and are paid on the last day of the corresponding year Their value should be based on the salary in effect at the time the bonuses are earned . The endorsement proceeds are paid in accordance with the terms of the deal . Remember that the timing of a cash flow affects the interest rate that is used to discount the cash flow. For example, annual interest rates should be used to discount annual cash flows, and monthly interest rates are used to discount monthly cash flows. Therefore, it may be necessary to compute the appropriate interest rate that should be used in a discounting calculation. (Hint: The performance bonus is paid once per year and therefore should be discounted using an annual interest rate.) .Round all dollar amounts to the nearest whole dollar and carry out all interest rate factors to four decimal places Henry Homerun-King's Contract Evaluation Worksheet 1 Assumptions and Calulated Values 2 Bank Rate Information: 3 Henry's Bank Account Rate (compounded monthly) 4Monthly Bank Rate 5Effective Annual Interest Rate 7.5000% 7 Salary and Bonus Information: 8 Annual Salary 9Monthly Salary 10 Discount factor (based on Cell B4 above) 11Discounted Annual Salary 12 13Moving Bonus 14 Discount factor (based on Cell B4 above) 15 Discounted Moving Bonus 16 17 Signing Bonus 18 Discount factor (based on Cell B5 above) Year 1 Year 2 Year 3 Total value $476,100 39,675 10.6960 $476,100 39,675 11.5264 457,310 9.9255 393,794 1.0000 7,500 1.0000 0.9280 0.8611 19 Discounted Signing Bonus 20 21 Time-in-League Bonus 22 Discount factor (based on Cell B5) 23 Discounted Time-in-League Bonus 24 25 Performance Bonus 26 Discount factor (based on Cell B5 above) 27 Discounted Performance Bonus 28 29 Monthly Endorsement Contract Payment 30 Discount factor (based on Cell B4 above) 31 Discounted Monthly Endorsement Payment 32 33 Contract's Total Nominal Value 34 Contract's Total Discounted Value 0.9280 0.9280 0.8611 0.7991 11.5264 Related Question: The restaurant owner creating Henry's endorsement opportunity can earn 8% (compounded seminannually) on his deposited funds Therefore, he would have to deposit Note: The future value interest factor of 8% compounded semiannually for one year is 2.0400.] every six months, starting on the day Henry signs his contract, to fund its endorsement contract