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Ohtani Contract TVM/NPV
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0:00
Imagine somebody offers you a $700 million contract over the next 10 years. Now, would you counter offer and say, actually, pay me just $2 million a year now for 10 years and gimme the rest later over a decade from now? It sounds crazy, right? Yet that's exactly what MLB Superstar, Shohei Ohtani did in his stunning 2023 deal with the Los Angeles Dodgers. Now Ohtani, one of baseball's most electrifying talents, signed a 10 year, $700 million contract, the largest in major league baseball
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history, but with a twist. He asked for most of that money much later, which is smart.
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Now, today we'll break down this fascinating contract and we'll use it as a real world example to learn about the TVM, meaning time, value of money, and NPV, which means net present value. And by the end, you'll understand why a dollar today. Is worth more than a dollar tomorrow, and how deferring payments changes the real value of Ohtani's deal and how these concepts apply to everyday personal finance and business decisions. So let's dive in.
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So Shohei Ohtani's contract with the Dodgers was not just record breaking in size, it was unprecedented in structure. The headline number is $700 million over 10 years, but. Otani is not actually getting paid that way in the usual sense. Instead, he's gonna earn only $2 million per year for the first 10 years, meaning between 2024 and 2033 totaling $20 million during the actual playing period of the contract. Now the remaining $680 million, which is about 97% of the contract
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value is deferred to the following 10 years, meaning 2034 to 2043. Now in those years when Ohtani may well be retired from playing, the Dodgers are gonna pay him a whooping $68 million per year from 2034 to 2043. Now, if you added it up, you get the full $700 million, but its as if Ohtani said. Don't give me most of my money until a decade from now. And this deferral was so massive that it dwarfs anything baseball has ever seen.
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Now, why would a player agree to pay me later on a fortune like this? Well, to answer that, we need to understand the concept of the time value of money. So here's a visual comparison of Shohei Ohtani's annual salary under the Dodgers contract. So from 2024 to 2033, he earns. Only $2 million each year, but from 2034 to 2043, he will earn $68 million per year highlighting how backend loaded his earnings are. Let's demystify the time value of money, meaning TVM.
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In simple terms, money now is worth more than the same amount of money in the future. Why? For two big reasons, earnings, potential, and inflation. Let's talk about earnings potential, meaning interest. If you have $1 today, you can invest it or put it in a savings account to earn interest. For example, if you received a hundred bucks right now and you put it in a bank at 5% annual interest, you'd have 105 bucks a year from now. Now I'm using 5% as an example, as we know that it can be tough to
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make that much in a bank account. And that means a hundred dollars today can turn into 105 bucks in one year just by sitting in your account. And here's the formula to calculate the future value. The future value or fv equals the present value, meaning PV times one plus R, which is the annual return to the power of N, meaning years. Now, if somebody offered you a hundred bucks now or a hundred bucks a year from now, it's a no brainer to take a hundred dollars right now.
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Because that $100 could be earning for you during the year. But what if somebody offered you a hundred dollars now or $110 in one year? Well, suddenly waiting a year might sound better because $110 in a year is worth more than the $105 you'd be getting by investing a hundred bucks now at 5%. And essentially, there's an opportunity cost to waiting for money you miss out on what you could have earned in the meantime. And this is why we often need more money in the future to make up
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for not having enough right now.
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Now let's talk about inflation, meaning prices rising over time, and so a dollar today generally buys you more goods and services than a dollar will in a decade. Of course. And think of how movie tickets or grocery prices have increased a lot compared to 10 to 20 years ago. Now, if inflation is say 3% per year, something that costs $100 now might cost about $134 in 10 years. And we can calculate this by using our future value formula, using 3% for the rate, and 10 for N meaning years.
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So a hundred bucks in the future isn't simply as powerful as a hundred dollars Now in terms of purchasing power. In short, the value of a dollar decreases over time. Now, if I give you a hundred bucks in 10 years and the annual interest rate is 3%, what is that 100 bucks in 10 years worth today? Well, we can rearrange our future value formula and solve for the present value. So the present value of a hundred dollars in 10 years in today's terms, meaning
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the present value at a 3% interest rate is only $74 and 41 cents, and the higher the interest rate or the longer you wait. The smaller the present value will be because you divide by a bigger number. Now let's apply the time value of money to Shohei Ohtani's contract. Let's pretend we're in 2024 and between 2024 and 2033, Otani makes $2 million per year, and then he makes $68 million per year starting in 2034 versus 2043. Now if we add up all the money he makes, we see at 700 million bucks.
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Now we have to discount these future payments so we can assess what the present value is for his entire contract. Now, recall that we're assuming that we're in 2024, so we don't need to discount the 2 million bucks he gets in 2024, but the 2 million bucks he gets in 2025 gets discounted using the present value formula for one year. Now, what discount rate should we use to calculate what the future payments are today, assuming it's 2024?
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Well, we use the rate from the yield curve for the US Treasury website. How do we do this? Well, let's go together to treasury.gov and let's click on data and then daily treasury par yield curve rates. Then let's select 2024 here and apply.
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Now since most of the money O will be getting is in 2034 through 2043, when he'll get 68 million bucks per year, we can discount this using the 10 or 20 year rate. And let's pretend that we're in May of 2024 and let's just use 4.43%. And we know the Dodgers will pay Ohtani a massive $68 million annually from 2034 to 2043 instead of during. 2024 to 2033. So what is the future money worth today? Well, in other words, what is a net present value? Meaning NPV of Ohtani, $700 million deal.
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So let's do the present value calculation for all future payments using a rate of 4.43%. And since we're in 2024, let's just assume that we don't discount the 2 million bucks. But for year two, we discount the 2 million bucks using one year. And our present value formula, and let's do the same here for all years. Now, if we add up all the payments he gets in those years, it's 700 million bucks. But if we add up the present value of all the payments, the present value
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is much lower at about $382 million. And there has to be an easier way to calculate all these present value numbers. And there is, and it's an Excel formula called NPV. Meaning net present value, and here's how you do it. All you do in Excel is you type equals NPV, open brackets. Then you enter the rate, which is 0.0443%. Then you hit comma, and then you highlight all the numbers you want to discount. Then close the brackets and add back the 2 million bucks from 2024, which is
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not getting discounted as, let's assume he's getting it right away in 2024. And we see here that the net present value is $382 million. And it turns out those future dollars are worth a lot less in today's terms. Now, at this point, you might be asking, why on earth would Ohtani agree to such a structure? If money now is better than money later, isn't he giving up a lot? Well, it turns out Ohtani has some very smart reasons. Number one, team strategy.
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He wants to help build a winner now, and Tani deferred his salary to give the Dodgers financial flexibility in the short term.
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Now by only taking $2 million a year during his playing years, he leaves tens of millions per year on the table that the team, meaning the Dodgers can use to sign other players and build a championship caliber roster while he's still playing for the Dodgers and a major league Baseball teams are constrained by a luxury tax threshold, also called the competitive balance tax, or CBT.
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Now for 2024, the CBT threshold was $237 million. And thanks to Ohtani's Deferrals, the Dodgers only have to count about 46 million uh, dollars salaries for him against that limit rather than closer to $70 million. And essentially, Ohtani's deferral lowered the immediate salary cap hit. Now a source explained that Shohei wasn't concerned about the exact annual leverage value, just that he wanted to help with flexibility for the team.
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And he effectively is betting that the Dodgers can use the freed up money to win multiple World Series titles while he's on the team. Of course, I'm a Blue Jays fan. Now, for a competitive athlete at Ohtani's level, the chance to win championships might be worth more than a few extra million dollars. Right now, here are the personal finance benefits. Ohtani is also playing the long game for his own financial benefits. Ohtani will likely make over a hundred million dollars in endorsements in
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2025, and that's 10 times more than the second highest player endorsement wise, which is Bryce Harper. Let's talk about taxes. Now, California, where I live, has one of the highest state income taxes. It's brutal at about 14% for top earners, and Ohtani will only earn $20 million in California during the contract's first decade, but, and here's the brilliance of it. The $680 million deferred will be paid after 2034 when he may no longer be a
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California resident, for example, if he retires and moves somewhere else. And a tax expert noted that if Ohtani moves out of California, by the time he collects those big checks, he could potentially avoid the 14% state tax on hundreds of millions of dollars and 14% of $680 million. Is a staggering $95 million here on the left coast, I mean the West coast. Now, even if he doesn't get all of that, the tax timing advantage could save him tens of millions. Here's another personal factor.
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Ohtani could afford to wait to get paid his salary as he makes a fortune from endorsements right now.
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So unlike most of us, Ohtani doesn't need. His full paycheck upfront to maintain his lifestyle. He has plenty of income in the meantime, and in essence, he's living off endorsement money now and letting the baseball salary pile pile up for later. Additionally, consider the cost of waiting for money depending on interest rates. In recent years, interest rates in Ohtani home country of Japan have been extremely low, close to zero, and even in the United States up until 2022, we had a long
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stretch of very, very low interest rates. Now in a low interest environment, the penalty for deferring money in terms of lost investment returns is much smaller. And to put it simply, if your money wouldn't have earned as much interest anyway, you don't lose much by getting paid later. And from one perspective, using Japan like ultra low interest rates, the present value of Ohtani's deferred contract could be calculated at around $65.9 million per
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year instead of $70 million, meaning he's barely giving up anything in real value. Now, of course, interest rates in the United States have risen recently, so by the typical US standards, he's sacrificing a fair bit more.
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But Ohtani might be optimistic about his investments or simply not too worried after all, because he's still one of the highest paid athletes ever on a present value basis. And importantly, he's banking on that. His team will be very successful, make the World Series and his off-field earnings will be unbelievable. Now in short, Ohtani deferred money is by choice. A highly unusual move for a superstar because he had a plan, help the team
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win now and possibly save on taxes, and he's finally secure enough to wait. Now, it's a really bold strategy that perfectly illustrates the push and pull. Of the time value of money in a real contract negotiation. And these concepts of time, value of money and net present value aren't just for million dollar baseball contracts. They're ideas that everybody can use in daily life with major financial decisions. Let's look at a couple of relatable examples. Lottery, jackpots, lump sum, or annuity.
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Do you ever wonder why lottery winners almost always take a lump sum cash payout? Instead of the full jackpot amounts in installments, well, it's because of the time value of money and the net present value. Now, lottery jackpots are advertised with a massive number, assuming you'll be paid annually over say 30 years. But if you choose the one-time lump sum, it's much less money in nominal terms, essentially the present value of those future payments.
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For example, a $400 million Powerball jackpot might only offer $200 million in a lump sum upfront. Why? Because that $400 million over 30 years when discounted back to today using the prevailing interest rates is worth about $200 million now, and the rest is what you would've earned in interest over those 30 years. Now most winners take the cash because $200 million now is often more valuable to them than $400 million slowly paid out, considering they can invest the
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money immediately and also due to concerns like inflation and not living long enough to collect 30 years of payments. The lottery example is exactly time, value, money at work, a burden one hand, meaning cash now versus two in the bush, meaning more money later. And each person's decision may differ. Some might prefer long-term stability of an annuity, but financially speaking, the net present value guides the calculation of that lump sum.
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Now, another everyday application of time, value of money is in saving for goals like retirement or college. And the reason financial advisors. Urge people to start saving early is not just a boring cliche. It's because money invested right now grows exponentially over time. Thank you. Compound interest.
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So $1,000 saved or invested in your twenties could grow to many, many times that amount by the time you retire. So start saving now please, and the future value of money can be massive. Conversely, if someone offers to pay you later rather than now, please be aware you're losing the growth you could have had. For instance, if your employer offers a bonus payable in two years, you might prefer a slightly smaller bonus now, or at least understand that a $10 bonus in two
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years is not the same as $10,000 today.
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You discount it to decide what it's really worth to you today. And this is essentially using NPV, meaning net per net present value in personal finance, comparing options by translating them into present dollars. And whenever you take a loan or a mortgage, the concept of present versus future money is at play. The bank gives you money now, which is great for you today, but you repay more and much more in the future. And that extra is interest reflecting the time value of money that you borrowed.
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Now, if you total up all your mortgage payments over 30 years, the number will be much larger than the amount you borrowed. However, the present value of those payments is equaled to what you borrowed, minus some adjustments for risk.
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Because the bank is essentially calculating that the money that you pay later when discounted equals the loan principle they gave you, and understanding time, value of money can really help you see through the log of long-term loans, credit card debt with very high interest rates, which makes future payment payments extremely costly and present value in financing deals too. And businesses live and die by the net present value rule.
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Now when a company considers a project, say, building a new factory or launching a new product, they estimate the future cash flows, revenues and costs. That project will generate year by year. Then they discount back those future cash flows back to the present value, using an appropriate interest rate, also called the discount rate, which reflects the cost of capital or acquired return. Now if the NPV meaning net present value, which is the sum of all discounted cash
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flows minus the initial investment cost. Is positive, it means the project is expected to create value and it's worth doing, but if it's negative, they might scrap the project because in today's dollars, it loses money. Now this approach is directly linked to TVM, meaning time, value of money. Money in the future is worth less, so you have to earn enough in the future to justify spending that money right now. And you can think of your personal decision similarly, for example, is
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going back to school for a degree worth it or not, and you might weigh the upfront tuition cost against the future, cash flows of a higher salary later, discounting them to see if the investment in education pays off. Now, while we don't always write out the formulas in everyday life, the concept is always lurking there. When we make trade-offs between now and later, it's important. And Shohei Ohtani's wild $700 million deferred contract is more than a sports headline.
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It's a perfect case study in the time value of money. And by examining this deal, we saw that $700 million in the future is not $700 million in today's value. When you crunch the numbers, it's more like $382 million. And Ohtani understood this yet he intentionally chose to delay his pay. Effectively betting on the future, trusting that the trade-off would bring championships to la I hope not, and perhaps even benefit his own finances
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in the long run through tax strategies and investments and the Dodgers for their parts get to enjoy more payroll flexibility thanks to the reduced present value cost of the contract. Both sides are leveraging TVME Time value, money. To their advantage in different ways. Now, for the rest of us Ohtani's deal is a vivid reminder that a buck now and a buck later are not the same thing.
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And whenever you make financial decisions, whether it's choosing how to receive money, evaluating investments, or planning for big expenses, remember to consider the timing. Ask questions like, would I prefer money now or later? Or how much more would I need in the future to make up for waiting?
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Or what's the net present value of these options? And these questions capture the essence of the time, value of money, and can really lead you to smarter choices. Now in the end, understanding time value of money, and the net present value really gives you a kind of financial superpower. The ability to compare apples to apples across time, and it lets you see through the hype of big numbers, like a $700 million contract or a $400 million
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lottery jackpot, and really understand what they're really worth today. And as we saw with Shohei Ohtani's contract, sometimes taking less now in exchange for more later can be part of a grand plan, but it only makes sense if you've done the math and thought through the trade-offs.
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Now that you're equipped with this knowledge, you can apply it in your own life, whether you're negotiating a salary, planning your investments, or just deciding when to purchase. Now, money is a dynamic thing and time is one of the most important ingredients. Just ask the guy who turned $700 million into a lesson for us all. Now, if you'd like to learn how to become a better investor and learn how to invest in stocks, real estate, and many other asset classes so you
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can materially increase your net worth in the long run, then please click the link in the description of this video to set up a call with my team to learn more about my courses, my one-on-one consulting, and much more. Thanks so much for watching, and if you found this breakdown fascinating, please hit that like button and remember. Time is money. Literally.
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Please subscribe for more insights and until next time, stay curious and financially savvy. Thank you. Time value of money sets and fires. Fast ball and it's, listen
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way back in. Hurry up.
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