Problem Statement and Approach: Texas rangers are planning to sign Baseball player Alex Rodriguez for a nominal value of 252 million $. The payment would be spanned over 10 years (from 2001 to 2010). The question that is baffling Texas Rangers is if this would turn into a profitable proposition in future, or will it spell doom for the company for signing a player with such a whopping amount. The proposed solution is to do a financial analysis of the situation based on the given data and using the Net Present Value concept.
The following is an explanation of how the annual cost outflow and inflow have been foreseen to decide upon the net cash inflow and then present value of it has been determined. It has been mentioned in the case that the Texas Rangers generally used an 8% discount rate for calculating comparable numbers. Cash Outflow: The analysis would be to measure the impact of Rodriguez’s recruitment on the team.
As per the case, the major expense on players included salaries (a little over 50%of total league expenses).
The other expenses include costs of player development, meal expenses, salaries for coach and trainers, players insurance etc. However, since enough data is not available for the other operational expenses and our task is to determine if recruitment of Alex Rodriguez would be a profitable investment, we may consider the salary component of the expenses as the only cash outflow.
Also, “the negotiating team believed that the right way to examine the financial attractiveness of the contract was only to consider that portion of his salary and insurance premium that would compensate for the extra tangible and intangible benefits he brought to the team” we could ignore the Signing Bonus component as well as the Deferred Amount component of the proposed contract for Rodriguez shown in Exhibit 5, thus taking into consideration for annual cash outflow only the base salary and the insurance premium that is 10% of the year’s contract value.
Thus, the cash outflow amounts foreseen for successive years from 2001-2010 are 21.1 million $ for the first four years (21 + 10%of21), 25. 5 million $ for the next two years, and 29. 7 million $ for four years after that. Cash Inflow: The most obvious benefit of Rodriguez’s recruitment would be increased attendance for Texas Rangers home games. Winning Teams drew more fans in Baseball, and though recruitment of any other star player would have affected the average number of victories by one or two games, it was estimated that Rodriguez’s recruitment would result in eight additional victories every season.
On an average, a customer spent 18$ for a ticket in addition to 2.50$ for parking and 1. 80$ in merchandise, making one single increase in attendance worth 22. 30$. Assuming that all the future increase in attendance may be due to the fame and exploits of Rodriguez on field, we need an estimate of increase in attendance to measure the impact of change in revenue that Rodriguez’s recruitment would include. Unfortunately, monitoring the Texas Rangers performance in the past 10 years and their attendance would show that there is no direct correlation between the number of victories and the attendances in their home games (From Exhibit 6).
For example, in the year 1994, the attendance in home games rose by more than 250,000 even though they won only 52 games in comparison to 86 in the previous year. However, it is also worthwhile noting that in this year, the team played only 62 home games as compared to 79 in the previous year. Similarly, the year 1995 saw them playing only 72 home games and an average attendance of 27,582. Though the total attendance decreased by 517,288, the team won 74 games: 22 more than previous year. Thus, finding a correlation between the number of wins and increased revenues generated is not feasible.
Another option may be to assume that Rodriguez’s performances take them to the most attended teams. At 2000, Texas Rangers do not have a total attendance of 3,000,000, although throughout its 80 games, it can support in excess of 3,930,000 people. The aim of recruiting Rodriguez is to increase attendance. If we assume that he is able to take the total attendances to above 3,000,000 levels (from 2,800,000) in 2000, we can calculate the cash inflow because of his inclusion. Also, we find (from Exhibit 6), that most teams in 2000 having 90 or more wins had attendance in excess of 3,000,000.
For the sake of calculations, the maximum attendance of the year 2000 was of Cleveland Indians (3,456,278). Thus, Rodriguez’s performance would have taken Texas Rangers an additional attendance of approximately 650,000. This if multiplied by income from each ticket (22. 30$ as calculate above) will generate an additional revenue of around 14. 5 million$. This, in addition with 10% of sponsorship revenue (higher limit of 7-10% sponsorship revenue) would give a revenue of about 16 million$ per year.
The revenue sharing transfers would decrease these, but so would any effort to increase the revenue, and thus we could safely neglect the effect in measuring the profitability of acquisition of Alex Rodriguez. This should also include the revenues generated from the team making it to the American League Championship Series and reaching the seventh game of the World Series. However, no data is provided to make any kind of estimate on how often the team is going to make it to these events, and hence they have not been accounted for in calculating the net Cash Inflow.
Net Present Value: The net result of going through with the deal following the above assumption is shown in the following Net Present Value Spreadsheet: Therefore, it is evident that if we do not consider Future Value of Money, the above deal results in a loss of $64. 6 million. However, taking into account that a dollar will have more value ad ticket prices are bound to increase and assuming an 8% interest rate, following spreadsheet shows the Net Present Value for above analysis:
Thus we see that the loss is considerably reduced if Future Value of Money is considered. Based on the above analysis, it can be recommended that investing in Alex Rodriguez is not a safe choice. However, the management should also consider the chances of making it to the American League Championships as well as the seventh game of world series, in addition to the intangible gains that recruitment of Rodriguez would bring, before making a decision.
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