Question

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7. In the year 2003, Frank Thomas had 4 years remaining on his Major League contract with the Chicago White Sox. Consistent with his contract, the Chicago 3 White Sox invoked the “minimum skills” clause of Frank Thomas’ contract. This allowed the Chicago White Sox to pay Frank Thomas the remaining 4 years of his guaranteed contract on a deferred basis. Under this constraint, Frank would be paid a total of $250,000 per year for the next four years (remainder of his contract). In addition, he would be paid the remaining $39 million evenly over the next 20 years (1.95 million/year), after the completion of his contract.

a.) If Frank faced an opportunity cost of 10% annually, what was the present value of his expected earnings in 2003?

b.) Alternatively, Frank Thomas could have declared free agency and had the ability to earn $5 million each year for the next four years (guaranteed), with another team. If he chose this option, what was the present value of free agency, again using an interest rate of 10%?

c.) If you were Frank Thomas’ agent and had to advise him on the best option financially from the two above, which would you advise him to take? (Maximizing Frank’s financial option is a win-win because it also maximizes your payout as his agent)

Answer 1

	Minimum skill cost
	1st 4 years	250,000.00	$
	Next 20 years	1,950,000.00	$
	Opportunity cost	10	%
		1.1
Minimum skill cost
Present Value of expected earnings as on 2003
Year	Amount	PV 10%	PV
1	250,000.00	0.909	227,272.73
2	250,000.00	0.826	206,611.57
3	250,000.00	0.751	187,828.70
4	250,000.00	0.683	170,753.36
5	1,950,000.00	0.621	1,210,796.58
6	1,950,000.00	0.564	1,100,724.16
7	1,950,000.00	0.513	1,000,658.33
8	1,950,000.00	0.467	909,689.39
9	1,950,000.00	0.424	826,990.36
10	1,950,000.00	0.386	751,809.41
11	1,950,000.00	0.350	683,463.10
12	1,950,000.00	0.319	621,330.09
13	1,950,000.00	0.290	564,845.54
14	1,950,000.00	0.263	513,495.95
15	1,950,000.00	0.239	466,814.50
16	1,950,000.00	0.218	424,376.81
17	1,950,000.00	0.198	385,797.10
18	1,950,000.00	0.180	350,724.64
19	1,950,000.00	0.164	318,840.58
20	1,950,000.00	0.149	289,855.07
21	1,950,000.00	0.135	263,504.61
22	1,950,000.00	0.123	239,549.65
23	1,950,000.00	0.112	217,772.41
24	1,950,000.00	0.102	197,974.92
Present Value of expected earnings as on 2003			12,131,479.58

Free agency
1-4 years	5,000,000.00	$
Opportunity cost	10	%
Free Agency
Present Value of expected earnings as on 2003
Year	Amount	PV 10%	PV
1	5,000,000.00	0.909	4,545,454.55
2	5,000,000.00	0.826	4,132,231.40
3	5,000,000.00	0.751	3,756,574.00
4	5,000,000.00	0.683	3,415,067.28
Present Value			15,849,327.23

Present value of minimum skill option is 12,131,479.58$.

As an agent of frank thomas I would advise him to choose the free agency option which give present value of 15,849,327.23$.

That is he will be able to gain an amount of 3717847.65$