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There are a lot of different ways to calculate the value of a contract,but understanding those methods can be surprisingly complex.
In my opinion, the three most crucial approaches are:
1) the Straightforward Calculation – 4 years, $240 million. This is the figure most often reported, but it doesn’t tell the whole story.
2) The Competitive Balance Tax (CBT) Value – This is crucial in baseball, as it impacts a team’s tax obligations.The CBT calculation is frequently enough a compromise between what teams want (lower values) and what players want (higher values). it makes the contract appear larger if future payments aren’t discounted.
The CBT value is based on Average Annual Value (AAV), calculated by dividing the total amount paid during the contract’s life (including the signing bonus) by the contract length. In this case, it’s ($240 million – $30 million in deferrals) $210 million / 4 years = $52.5 million. The deferred payments are then added back in. Any money deferred for 10 or more years is discounted-that’s why most deferrals are structured that way. Assuming this applies to the contract in question, that’s four payments of ($30/4) $7.5 million, starting 10 years from now.
You can estimate the present value of these deferred payments using a calculator like this:
calculator.net/present-value-calculator.html?cyear…
Four yearly payments of $7.5 million at a 5% discount rate have a value of $26.6 million. However, that $26.6 million must then be discounted another 10 years,bringing its present value down to $16.3 million. Now, the total contract value is ($210 million plus $16.3 million) $226.3 million. Dividing by 4 gives an AAV of approximately $54 million per year.
*My calculations consistently come up slightly lower than the official figures. I suspect this is due to the discount rate used, but the process itself appears to be correct.
3) The Financial Present Value – there’s the financial present value, representing the money from both the player’s and the team’s perspectives.
First,consider the signing bonus. In this case, the $64 million bonus is paid upfront, so its value is simply $64 million.
Next, the regular payments total ($240 million – $64 million signing bonus – $30 million deferred) $146 million over 4 years, or $36.5 million per year. Discounting this yields a present value of $129.4 million.
calculator.net/present-value-calculator.html?cyear…
Adding in the $16.3 million from the deferred payments, the total comes to ($64 + $129.4 + $16.3) $209.7 million.
Therefore, a $240 million contract can have a value of $240 million, $226 million, or $209.7 million, depending on the calculation method used.
