Max Scherzer and Net Present Value

A quick note on what Scherzer‘s deferral really means. I already did a longer analysis of the move and what it means for the team. But here I just want to talk contract terms.

His total contract value of $210 million is reported to have a big chunk deferred.

The Nats won’t have to pay him $210/7 or $30 M per season. Instead they pay $15M per season. What that means in layman’s terms, is that the Nats will have to keep paying him much longer than he is useful to them. For him, he gets to keep making money long after he retires.

But it’s not so simple. It is advantageous for the Nationals because of a concept used by all businesses and economists known as the time value of money. Money today is worth more than money tomorrow, for a bunch of reasons. In other words, the present value (what it’s worth to him now) of $15 M given to Scherzer in 2028 is different than the present value of $15 M given to him today.

The rate of interest is what modifies how much each payment is worth in today’s money. Assuming the US inflation rate of 2% over the next decade, and using that as the interest rate on the calculation, we get a net present value of $185 M

NPV 2p

However, if the economy is loosened a bit, with it’s impressive growth over the last few years, then the inflation rate may end up being significantly higher. If we set it at 4%, certainly not what we’ve seen in the last decade but something that is not at all unprecedented, the deal is worth more like $165 M:

NPV 4p

Net present value is simple on the surface, but determining the interest rate to use can be a complex process. One that I might not have been able to explain perfectly when I was in business school, let alone now.

Suffice to say, this is a gross oversimplification, but hopefully it gets the point across – while Scherzer did sign for $210 M, it’s not worth $210 M to the Nats or to Scherzer in terms of today’s money. This makes the deal significantly more appealing to the team than a standard deal, and may be what made them jump at the chance to sign him, even though they already had a loaded rotation.

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  1. Pingback: Making Sense Of The Max Scherzer Deal | Mr. Irrelevant, a D.C. Sports Blog by the Brothers Mottram

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