Question

Case Study

Roberto’s Good Fortune

Roberto Cement has been a baseball player all of his life, and recently was drafted by a professional

team to play in the major leagues (late 2019). Right now his plan was to play with a minor league club

while his contract negotiations are being finalized with the team that drafted him.

Roberto has played baseball in an organized league since he was seven years old, and was a

standout/star player in high school and college. He had been recruited by a number of colleges, and

decided on the one that had the best record of sending players to the major leagues. He was in his

junior year of college when he decided to declare himself eligible for the draft – and that’s what he did.

Just before the draft, Roberto took his father’s advice and hired an agent to help him navigate the

process of the draft and the follow up negotiations with the professional team that would most likely

draft him. He finally chose an agent who was an acquaintance of his friend and fellow baseball player,

Barry, who had been drafted several years ago.

Roberto’s agent, Marvin Moneybags, thinks he knows what the offer will be from the major league club.

And, he believes he has a better counterproposal. Roberto has also been talking to a friend who has

been playing in the major leagues for about five years, and came through the system very similarly to

the way Roberto is managing his career. This friend, Barry (referred to previously), also has suggested

some contract ideas and a starting point for negotiations. Roberto’s contract with Marvin (his agent) will

run for the same term as the contract with the team, and will be renegotiated toward the end of the 5

year term of the original contract.

Roberto, his friend Barry, and his agent Marvin finally developed three offers/proposals that they

thought are the most likely scenarios, and they are as follow:

Offer #1

1. The offer from the team, which Marvin is pretty sure of, consists of the following:



A $125,000 signing bonus to be received in cash on the day of signing the contract.

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

A five-year contract for $240,000 per year, paid at the beginning of the year, with some

additional incentive money if he performs above certain criteria.



The incentive money consists of a lump sum amount of $35,000 to be received at the end of

each year for the five-year contract term, if he meets the incentive requirements.



A re-signing bonus of $200,000 to be paid at the end of his contract term, if both he and the

team decide to enter into a new contract.

Offer #2

2. The second offer to consider is Marvin’s counterproposal, which is structured as follows:



A $160,000 signing bonus to be received in cash on the day of signing the contract.



A five-year contract for $250,000 per year, paid at the beginning of the year, with some

additional incentive money if he performs above certain criteria.



The incentive money consists of a lump sum amount of $40,000 to be received at the end of

each year for the five-year contract term, if he meets the incentive requirements.



A re-signing bonus of $200,000 to be paid at the end of his contract term if both he and the

team decide to enter into a new contract.

Offer #3

3. The third offer/proposal that Roberto is considering is the one that he and his friend worked on

together. They both feel that this is in Roberto’s best interest.



A $175,000 signing bonus to be received in cash on the day of signing the contract.



A five-year contract for $270,000 per year, paid at the beginning of each year, with some

additional incentive money if he performs above certain criteria.



The incentive money would consist of a lump sum amount of $60,000 to be received at the

end of each year for the five-year contract term, if he meets the incentive requirements.



No re-signing bonus at the end of the contract term. Roberto’s friend thinks that the best

approach is to negotiate from the perspective of becoming a free agent – if he’s doing really

well, it puts additional pressure on the team to come up with even more money in a re-

signing bonus situation.

Roberto and his friend, Barry, know that they will need some help in analyzing these offers. Neither of

them had any business courses in college, and certainly don’t know about the time value of money.

However, they both know you (you went to college with them and went on to get your masters degree)

and they also know that you are good at analyzing relevant cash flows and financial situations.

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Roberto and Barry have enlisted your support and would like the following questions answered, given

the assumptions of an interest rate (or discount rate) of 7% for all three proposals, and have asked that

you round the computations to the nearest dollar:

1. From a financial and time value of money perspective, you will analyze each offer. You’ve told

them that you will have to calculate all of the future cash flows discounted back to the present to

be able to compare the three offers fairly and effectively.

Find the total present value (PV) of each of the three offers.

2. Which offer is best, based strictly on the financial calculations (#1 Team Offer; #2 Marvin’s

counterproposal; #3 Roberto and Barry’s proposal)?

And why?

3. What additional considerations should Roberto think about in terms of:



the amounts and timing of the cash flows?



the incentive component of the offer?



the re-signing bonus (or absence of one, as in the third offer)?

4. Which offer do you think Roberto’s agent, Marvin, will recommend?

And why?

(Note: Marvin will probably get about 10% of the total contract value, not including the

incentives, but including both signing and re-signing bonuses.)

5. Are there any other choices or options that Roberto could evaluate, other than those being

considered here? What are your ideas?

[Note: This question addresses section E (Other Options) in the Case Study Methodology]

6. Which offer do you recommend for Roberto, given all of the considerations?

[Note: This question addresses section F (Your Prediction) in the Case Study Methodology

Answer 1

1. Present value of offers:

Offer 1 - Team Offer

Year	Signing Bonus	Contract money	Incentive	Re-signing bonus	Marvin's 10% commission	Total Cash-inflow	Discount rate at 7%	Present Value of cash flows
0	125,000	240,000			(36,500)	328,500	1.000	328,500
1		240,000	35,000		(24,000)	251,000	0.935	234,579
2		240,000	35,000		(24,000)	251,000	0.873	219,233
3		240,000	35,000		(24,000)	251,000	0.816	204,891
4		240,000	35,000		(24,000)	251,000	0.763	191,487
5			35,000	200,000	(20,000)	215,000	0.713	153,292
Total								1,331,982

Present Value of Offer 1 (Team Offer )= $1,331,982

Offer 2 - Marvins's Counter Proposal

Year	Signing Bonus	Contract money	Incentive	Re-signing bonus	Marvin's 10% commission	Total Cash-inflow	Discount rate at 7%	Present Value of cash flows
0	160,000	250,000			(41,000)	369,000	1.000	369,000
1		250,000	40,000		(25,000)	265,000	0.935	247,664
2		250,000	40,000		(25,000)	265,000	0.873	231,461
3		250,000	40,000		(25,000)	265,000	0.816	216,319
4		250,000	40,000		(25,000)	265,000	0.763	202,167
5			40,000	200,000	(20,000)	220,000	0.713	156,857
Total								1,423,468

Present Value of Offer 2 (Marvin's Counter Proposal) = $1,423,468

Offer 3 -Roberto & Barry Proposal:

Year	Signing Bonus	Contract money	Incentive	Re-signing bonus	Marvin's 10% commission	Total Cash-inflow	Discount rate at 7%	Present Value of cash flows
0	175,000	270,000			(44,500)	400,500	1.000	400,500
1		270,000	60,000		(27,000)	303,000	0.935	283,178
2		270,000	60,000		(27,000)	303,000	0.873	264,652
3		270,000	60,000		(27,000)	303,000	0.816	247,338
4		270,000	60,000		(27,000)	303,000	0.763	231,157
5			60,000	-	-	60,000	0.713	42,779
Total								1,469,604

Present Value of Offer 3 (Roberto & Barry Proposal) = $1,469,604

Working notes:

a. Signing Bonus is received immediately - hence its a cash-flow in year 0

b. Contract money is paid at the beginning of the year - hence the first money is received in year 0

c. Incentive is paid at the end of the year - hence the first money is received in year 1

d. Re-signing bonus is paid at the end of the term - hence its a cash flow in year 5

e. Roberto's agent, Marvin probably might get 10% commission on Signing Bonus, Contract money & re-signing bonus (excluding incentive). Thus, his commission is taken at 10% every year on the total of Signing Bonus, Contract money & re-signing bonus for that year. Since, its a cash-out flow for Roberto, it is shown as negative

f. discount rate is computed as

Year 1 = 1/(100%+7%)^1; Year 2 = 1/(100%+7%)^2; Year 3 = 1/(100%+7%)^3; Year 4 = 1/(100%+7%)^4; Year 5 = 1/(100%+7%)^5

g. Total cash-inflow for the year is the sum of Signing Bonus  , Contract money, Incentive, Marvin's commission (in negative) & Re-signing bonus

h. Present value of cash-inflows is computed as Total cash-inflow for the year * Discount rate

i. Total is the total of present value of all yearly cash-inflows

2. Which offer is best

Of all the 3 offers, Offer 3 (Roberto & Barry Proposal) which has the highest Present Value of  $1,469,604 is to be chosen.Thus, Roberto will be earning the highest in offer 3.

3. Additional considerations:

Amount and timing of cash-flows : while choosing offer 3, Roberto must be considerate that each of the cash-flows at agreed amount and also at agreed timing is to be adhered too. Any change in these will impact the present-value. For example, if contract money is received at the end of the year instead of beginning of the year, then the first money will be received in year 1 (instead of year 0) and last money in year 5 (instead of year 4) and the present value will change as follows:

Total Present Value = $1,469,604 - present value of contract money of year 1 (net of Marvin's commission) + present value of contract money of year 5 (net of Marvin's commission) = $1,469,604 - ($270,000*(100%-10%)) + ($270,000*(100%-10%)*(1/((100%+7%)^5)) = $1,469,604-$243,000+$173,256=$1,399,860. Thus, this will be lesser than offer 2 (Marvin's counter proposal) NPV of $1,423,468 and hence not profitable for Roberto.

Incentive component of the offer : Roberto should also be considerate on the incentive component of the offer. Any change in incentive amount will significantly impact the present-value. For example, if the incentive for offer 3 is reduced from $60,000 to $40,000, then the the present value will change as follows:

Total Present Value = $1,469,604 - total present value of incentive money of $60,000 + total present value of incentive money of $40,000 = $1,469,604 - ($60,000*4.100) + ($40,000*4.100) = $1,469,604-$246,012+$164,008=$1,387,600. Thus, this will be lesser than offer 2 (Marvin's counter proposal) NPV of $1,423,468 and hence not profitable for Roberto. As can be seen, $20,000 reduction in incentive reduces offer 3 NPV by $82,004 ($1,469,604-$1,387,600) and hence for every $1 reduction in incentive, offer 3 NPV will reduce by $4 ($82,000/$20,000).

4. Which offer Marvin will recommend?

Roberto's agent, Marvin probably might get 10% commission on Signing Bonus, Contract money & re-signing bonus (excluding incentive). Thus, his commission is taken at 10% every year on the total of Signing Bonus, Contract money & re-signing bonus for that year. Thus, he will recommend that offer which gives him the maximum present value of cash-flow.

	Offer-1	Offer-2	Offer-3
Year	Commission at 10%	Present Value of commission	Commission at 10%	Present Value of commission	Commission at 10%	Present Value of commission
0	36,500	36,500	41,000	41,000	44,500	44,500
1	24,000	22,430	25,000	23,364	27,000	25,234
2	24,000	20,963	25,000	21,836	27,000	23,583
3	24,000	19,591	25,000	20,407	27,000	22,040
4	24,000	18,309	25,000	19,072	27,000	20,598
5	20,000	14,260	20,000	14,260	-	-
Total		132,053		139,940		135,955

Since, Marvin's present value of commission is highest at offer-2 at $139,940, he will recommend offer-2.

Working notes:

Commission at 10% = taken from the tables in answer (1)

Present value of commission = Commission at 10% * discount factor at 7% applicable for the respective year (as given in working note (f) under answer (1).

5. Option 3 is recommended considering the following:

a. It has the highest NPV

b. This is highest even without re-signing bonus. Thus, if Roberto performs really well, his chances of re-signing will be high and it can generate additional cash-flows for him.

c. This offer is made by Roberto and Barry in Roberto's best interest unlike Option 2 where Marvin has vested interests.