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 93 mph fastball, an impeccable curve ball and slider, and a reliable changeup pitch, he achieved a 15-2 win–loss record, an earned run average (ERA) of 2.76, and 123 strikeouts in 99.1 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, Marty Fineprint, indicating that he is being called up to the Mobile Bayhoppers, the Cowboys’s corresponding Major League Baseball (MLB) team. Moreover, Harry’s contract is being revised to reflect his new status. The email describes the general terms and conditions of Harry’s revised contract.

Harry,

Congratulations! You’ve been called up to the Mobile Bayhoppers. Below are the offered terms and conditions of your new contract. After you review them and think about the offer, call me and we’ll discuss your options. Congrats again!

Salary and Incentives:

•	Harry Hurler hereafter referred to as the “Player,” is offered a four-year contract with an annual salary of $474,000 per year, to be paid at the end of each month in the contract term.
•	Under the league’s collective bargaining agreement, the Player will receive a 4% cost-of-living adjustment (COLA) to his annual salary at the beginning of every other year. This means that the Player’s annual salary will increase at the beginning of year 2 and year 4, as applicable.
•	In addition, the Player will receive a one-time $20,000 time-in-league bonus after six months of participation with an MLB team. This bonus will be paid immediately on completion of the six-month period.
•	The Player is offered a performance-based bonus, as well as a milestone bonus. Both are intended to encourage outstanding performance.
•	The Player is offered the following award-based performance incentive: a 15% bonus if he is designated as the Most Valuable Player (MVP) in the league. The Player is also offered the following milestone bonus: a $125,000 bonus if he ties Nolan Ryan’s 1973 single-season strikeout record (383 strikeouts).
•	The Player is eligible for each potential bonus each year that the contract is in effect and, if expressed as a percentage, will be based on the value of the Player’s base annual salary for the corresponding year. If earned, the performance and milestone bonuses will be distributed in a single payment at the beginning of the next contract year. Although this proposal describes only one milestone, the actual contract contains several progressive milestones. Exceeding one milestone creates the opportunity to exceed another.

In addition to the proposal offered by the Bayhoppers, I’ve also been able to secure the following endorsement opportunity:

A local car dealer has offered you a contract that will pay $2,750 per month for two years. This contract is contingent on your accepting the contract with the Bayhoppers and will take effect immediately upon signing your MLB contract. In return for these payments, you will participate in the dealer’s promotional events, such as signing autographs and allowing photographs as requested.

Harry is so excited! According to Marty, the contract is worth $2,760,400—assuming 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 Marty’s calculations. After an extended conversation about what he’ll do with his newfound wealth, you and Harry have agreed that any funds received could be invested to earn 7.00%, 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.

 

1 Assumptions and Calculated Values Bank Rate Information: Harry's Bank Account Rate (compounded monthly) 2 3 4 5 6 7 8 9 10 A Monthly Bank Rate Effective Annual Interest Rate 19 Salary and Bonus Information: Annual Salary ( 4% COLA) Monthly Salary Discount factor (based on Cell B4 above) 11 Discounted Annual Salary 12 13 Time-in-League Bonus 14 Discount factor (based on Cell B4 above) 15 Discounted Time-in-League Bonus 16 17 Milestone Bonus 18 Discount factor (based on Cell B5 above) Discounted Milestone Bonus $ $ $ $ $ $ $ B 7.00 % Year 1 11.5571 0.9657 0.9326 % % $ Year 2 10.7780 0.8697 $ Year 3 10.0514 0.8111 $ $ $ E Year 4 9.3737 0.7564 F Total value $