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Maybe you've about Bobby Bonilla, he was a major league baseball player for 16 years.
He was an all-star.
He played for the Pirates, and the Mets.
He even won a championship with the Florida Marlins.
Now, you wouldn't think that Bobby Bonilla would have been in the situation
to use future value and present value calculations, but in fact, he was.
So in 1999, the New York Mets are paying him about $6 million a year.
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don't put me on your team, but I do want that money.
Except, I'm okay about not receiving the money today.
I would like to receive the money in the future and so,
they made an agreement that starting in 2011, it's July 1st as a matter of fact.
And ending on July 1st of 2035,
Bobby Bonilla would collect an annual paycheck of $1,193,248.
So Bobby Bonilla put off $5.9
million in the year 2000.
And he agreed to collect 25 annual
payments of $1,193,248.
What is the mathematics of this?
Let me show you, of course, this is a future value, present value calculation.
And it must be that the future value of $1 million payouts has got to be,
either exactly equal to $5.9 million, or
from Bobby Bonilla's standpoint, has to be worth more,
because he certainly, wouldn't accept less.
How do we know what it exactly worth?
Of course, we've done the calculations and
we know that we have to find the interest rate such that
the sum of all of the payouts of $1,193,248.
Starting 11 years from when he agreed,
all the way through the year 2035 must be equal to his $5.9 million.
So if he puts it into an interest bearing account.
Like If he had taken his $5.9 million and put it into an interest bearing account,
it would be worth something 35 years from now.
So we had to ask essentially what is the interest that he would be
giving up in order to accumulate this?
And so, at an interest of 8%, Bobby Bonilla’s
present value of equal payments of 1,193,248,
starting in the years 2011 and
going all the way through 2035,
would exactly be equal to $5.9 million if
he had received it in the year 2000.
So from here, we can identify that Bobby Bonilla's discount rate is 8%.
Well then, why would the Mets be willing to pay this?
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Obviously, they had a different discount rate and so for the Mets,
they must have identified that they needed the money now.
Their discount rate must have been larger.
So the bigger your discount rate, the more you discount money in the future.
The smaller your discount rate, the more you value money now.
And so, the Mets must have had a larger discount rate because they
were willing to give Bobby Bonilla all of this money in the future.
And they wanted the $6 million right now.
Here are the calculations, we receive the annuity table for
Bobby Bonilla and for the Mets.
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So if the Mets were able to get their money
cheaper than Bobby Bonilla could raise his money.
Essentially, the money that Bobby Bonilla would put into an interest bearing account
if the Mets can get their money cheaper than that.
Then the Mets would be happy.
Everybody would be happy.
So let me back track again and explain to you what's going on.
Bobby Bonilla gives up $6 million, he receives
a whole bunch of money in the future, equal payments of 1 million in change,
the Mets are willing to do this because they have a high discount rate.
Bobby Bonilla is willing to do this because he has a low discount rate.
He doesn't value the money today as much as he does in the future.
The Mets value the money more today, than they would in the future.
Everybody is happy, and
everybody is using the present value, future value calculation.
Good decisions are made when you use good finance.
Thomas SmithAssistant Professor in the Practice of Finance
