16. Application of Time Value of Money Skills

Harry Hurler has been playing baseball since he was five years old and has always dreamed of playing in the big leagues. Last season, he was a starting pitcher for a double-A (AA)-level baseball team, the Dodge City Cowboys; last year, he was the first runner-up for the Minor League Player of the Year award. Using his 96 mph fastball, an impeccable curve ball and slider, and a reliable changeup pitch, he achieved a 16-3 winloss record, an earned run average (ERA) of 2.98, and 146 strikeouts in 117.0 innings pitched. He is also your best friend.

Two weeks ago, on his three-year anniversary with the team, Harry received the following email from his agent, George Get-dBucks, indicating that he is being called up to the Wichita Wizards, the Cowboyss corresponding Major League Baseball (MLB) team. Moreover, Harrys contract is being revised to reflect his new status. The email describes the general terms and conditions of Harrys revised contract.

From: George Get-dBucks

To: Harry Hurler

Harry is so excited! According to George, the contract is worth $3,412,400assuming receipt of all possible bonuses. After rereading the email twice and calling his family, Harry called you to review the terms of the contract and verify Georges calculations. After an extended conversation about what hell do with his newfound wealth, you and Harry have agreed that any funds received could be invested to earn 7.50%, compounded monthly.

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 at the end of the corresponding year(s), unless specifically stated differently. Their value should be based on the salary in effect at the time the bonuses were 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.
	Round all dollar amounts to the nearest whole dollar and carry out all interest rate factors to four decimal places.
	When entering intermediate values as answer choices, be sure to round them to the nearest dollar, however when using those same values to calculate another answer, do not round.

Harry Hurler's Contract Evaluation Worksheet

	A	B	C	D	E	F
1	Assumptions and Calculated Values
2	Bank Rate Information:
3	Harry's Bank Account Rate (compounded monthly)	%
4	Monthly Bank Rate	%
5	Effective Annual Interest Rate	%
6
7	Salary and Bonus Information:	Year 1	Year 2	Year 3	Year 4	Total value
8	Annual Salary (4% COLA)
9	Monthly Salary
10	Discount factor (based on Cell B4 above)	11.5264	10.6960	9.9255	9.2105
11	Discounted Annual Salary
12
13	Time-in-League Bonus
14	Discount factor (based on Cell B4 above)	0.9633
15	Discounted Time-in-League Bonus
16
17	Milestone Bonus
18	Discount factor (based on Cell B5 above)	0.9280	0.8611	0.7991	0.7415
19	Discounted Milestone Bonus
20
21	Performance Bonus
22	Discount factor (based on Cell B5 above)	0.9280	0.8611	0.7991	0.7415
23	Discounted Performance Bonus
24
25	Monthly Endorsement Contract Payment
26	Discount factor (based on Cell B4 above)	11.5264	10.6960
27	Discounted Monthly Endorsement Payment
28
29	Contracts Total Nominal Value
30	Contracts Total Discounted Value					1. Given your worksheet calculations, which of the following statements is accurate? Is Georges estimate of the value of Harrys contract accurate on either a nominal or discounted basis? Check all that apply. Georges estimate of the value of Harrys contract is incorrect on a nominal basis, and the error is $50,389. It is appropriate and necessary to discount the performance bonus using the bank accounts effective annual interest rate because of differences in the timing of the compounding of the bank account and that of the payments for the performance bonus. Georges estimate of the nominal value of Harrys contract is correct. Related Question: The local car dealer creating Harry's endorsement opportunity can earn 6% (compounded quarterly) on his deposited funds. She would have to deposit each quarter, starting exactly two years before the day Harry signs his contract, to fund her endorsement contract. [Note: The future value interest factor of 6% compounded quarterly for eight quarterly periods is 8.4328.]