The baseball world was surprised to hear that the Dodgers signed Shohei Ohtani to a staggering $700 million contract. That is 70% of a billion dollars just to play baseball! This column is an accountant’s wonky analysis of the actual costs.
The Angels paid Mike Trout $426.5 million. Last year the Yankees signed Aaron Judge to a $400 million contract. Before this year, those were the two highest contracts ever signed by baseball players. So is Ohtani really getting paid almost $275 million more than Trout and $300 million more than Judge?
There is one huge difference between Ohtani’s contract and the others. Substantially all of Ohtani’s contract payments are deferred. He will be paid $2 million per season for the 10 years he will play for the Dodgers. Then after that, he will be paid $68 million annually for the following 10 years. So his deal is stretched out 10 years after he has played his last game under the contract.
Everyone knows that, because of inflation, a dollar is worth more today than it will be worth in the future. The question is how much to discount those future payments to determine how much they are worth in today’s dollars.
Those who have taken a finance class in college are familiar with the term “net present value” or NPV. (This is the wonky part.) The NPV of an investment is the value, expressed in current dollars, of the future return on an amount of money that has been invested at a compound rate of interest. Sometimes the rate of interest is what the borrower would pay to fully finance the investment. Other times the rate of interest is the amount that could be earned from an alternative investment, such as investing in U.S. Treasury obligations. Choosing an “appropriate” interest rate is quite subjective.
NPV is commonly used in capital budgeting and investment planning to analyze the profitability of a projected investment or project. If you know how to use Microsoft Excel spreadsheets, computing NPV is fairly simple.
I went online to www.spotrac.com/mlb, which contains a chart for all major league ballplayers showing their current contract payments by year. You can copy that information and paste it into a column in an Excel spreadsheet.
Then go to formulas on the Excel tool bar at the top of the screen and select the formula called NPV. A dialog box will appear into which you enter the interest rate and highlight the cells in the column. Excel will then compute the net present value of the highlighted amounts entered in that column.
When applying a 6% interest rate to Ohtani’s contract, the NPV of the $700 million he is owed is a mere $294,188,897. In other words, the payments he will receive, when expressed in today’s dollars, are less than half the stated dollar amount of the contract.
I chose a 6% interest rate because that approximates the average rate of inflation over the past 50 years and because it is around 3% higher than the rate paid on 10-year U.S. Treasury obligations. That rate is a commonly used benchmark for comparing the return on long-term investments. If you think another interest rate is more appropriate, you can calculate your own NPV using that rate. Doing this is a relatively simple task in an Excel spreadsheet.
I then computed the NPV for Mike Trout’s contract. Trout was paid a $20 million signing bonus and has no deferred payments. NPV of his $426.5 million contract is $304,002,713, which exceeds the NPV of Ohtani’s contract by $10 million.
I also calculated the NPV of the $400 million contract that Aaron Judge signed last year. The NPV of that contract is $294,403,482, an amount that is very close to that of Ohtani’s contract.
So when compared to the highest contracts signed in the past, Ohtani’s contract amount is not that surprising after discounting the payments for future inflation.
Based on what has been published about competing offers from the Toronto Blue Jays and the San Francisco Giants, it sounds like their offers were in the same ballpark as that of the Dodgers. (No pun intended.) So clearly each team’s bean counters were on the same page and the Dodgers were not taken to the cleaners.
While the contract’s NPV is heavily discounted from the contract’s stated amount, unfortunately for Dodger fans, the NPV of ticket prices and the cost of a beer will be the price paid because payment for those items cannot be deferred.
Jim de Bree is a Valencia resident who has been a Dodger fan for 63 years and has practiced accounting for 50 years.