Alex Rodriguez - Baseball Player Payout

Background:

Alex Rodriguez, the best young player in Baseball is currently playing for Seattle Mariners. His current compensation is $4 million/year. His contract with Mariners ended in 2000 and he is now able to freely negotiate with any of the 30 teams. All the teams are aggressively trying to sign him owing to his ongoing performance.

Problem statement

The Texas Rangers is trying to sign Rodriguez for the next 10 years starting 2001 and in return expecting additional return which will fetch more attendance in Rangers’ home ground generation more revenue. The offer amount for contract has been decided to be $252 million which is at a much higher range when compared with normal trends. The offer amount surpasses that of any other current player’s salaries. The Rangers are trying to assess if the offered amount is financially justifiable.

Analysis

The first step towards our analysis is to calculate the incremental cost Rangers would incur by signing Alex Rodriguez. There are several components of Rodriguez’s contract.

As per the contract –

1. Rodriguez would be given 10 million dollar signing bonus to be paid evenly over the first five years
2. A portion of each year’s compensation would be deferred for 10 years @ 3% interest rate
3. A premium attached to the contract @10% for the period of the contract

To do this, we calculated the pay-outs of Rodriguez for the contract period of 2001-2010 and the deferred pay period of 2011-2020.

For Period 2001-2010:

Payout = Base salary + Signing Bonus (For Example: Payout = 21 + 2 = $23 million/year for 2001)

Annual Salary = Payout – Deferred Amount

For Period 2011-2020:

Annual Salary = Deferred Payout @3%

Insurance Premium: 10% of annual salary for period 2001-2010

Annual Salary on account of Rodriguez = Annual salary + Insurance premium

Total Annual cost of hiring Rodriguez = $289.58 million

From the above Annual Cost, we deducted the minimum cost of hiring a shortstop to arrive at incremental cost as Rodriguez would replace a shortstop. The minimum cost of hiring a shortstop has been considered to be $3 million in 2000, then $3.3 million in 2001 (assuming 10% interest applied year on year) and so on till 2010.

So, Total cost of hiring a shortstop = $52.59 million

Therefore, Total Incremental costs of signing Alex Rodriguez from 2001 till 2020 =

$(289.58 – 52.59) million = $236.99 million

The incremental cost is then converted to present value assuming 8% discount rate

So, the

Pre-tax present value of the incremental costs of signing Alex Rodriguez = $140.76 million

(Exhibit 1)

During the following analysis, for all present value calculation Discount rate has been considered as 8%.

In the next step, we calculated the number of additional tickets Rangers would be able to sell and amount of additional revenue which would be generated if Rodriguez is signed on.