Response to the following problem:
Chesterfield Wanderers is a professional football club that has enjoyed considerable success in both national and European competitions in recent years. As a result, the club has accumulated £10m to spend on its further development. The board of directors is currently considering two mutually exclusive options for spending the funds available. The first option is to acquire another player. The team manager has expressed a keen interest in acquiring Basil (‘Bazza') Ramsey, a central defender, who currently plays for a rival club. The rival club has agreed to release the player immediately for £10m if required. A decision to acquire ‘Bazza' Ramsey would mean that the existing central defender, Vinnie Smith, could be sold to another club. Chesterfield Wanderers has recently received an offer of £2.2m for this player. This offer is still open but will only be accepted if ‘Bazza' Ramsey joins Chesterfield Wanderers. If this does not happen, Vinnie Smith will be expected to stay on with the club until the end of his playing career in five years' time. During this period, Vinnie will receive an annual salary of £400,000 and a loyalty bonus of £200,000 at the end of his five-year period with the club. Assuming ‘Bazza' Ramsey is acquired, the team manager estimates that gate receipts will increase by £2.5m in the first year and £1.3m in each of the four following years. There will also be an increase in advertising and sponsorship revenues of £1.2m for each of the next five years if the player is acquired. At the end of five years, the player can be sold to a club in a lower division and Chesterfield Wanderers will expect to receive £1m as a transfer fee. During his period at the club, ‘Bazza' will receive an annual salary of £800,000 and a loyalty bonus of £400,000 after five years. The second option is for the club to improve its ground facilities. The west stand could be extended and executive boxes could be built for businesses wishing to offer corporate hospitality to clients. These improvements would also cost £10m and would take one year to complete. During this period, the west stand would be closed, resulting in a reduction of gate receipts of £1.8m. However, gate receipts for each of the following four years would be £4.4m higher than current receipts. In five years' time, the club has plans to sell the existing grounds and to move to a new stadium nearby. Improving the ground facilities is not expected to affect the ground's value when it comes to be sold. Payment for the improvements will be made when the work has been completed at the end of the first year. Whichever option is chosen, the board of directors has decided to take on additional ground staff. The additional wages bill is expected to be £350,000 a year over the next five years. The club has a cost of capital of 10 per cent. Ignore taxation.
Required:
(a) Calculate the incremental cash flows arising from each of the options available to the club.
(b) Calculate the net present value of each of the options.
(c) On the basis of the calculations made in (b) above, which of the two options would you choose and why?
(d) Discuss the validity of using the net present value method in making investment decisions for a professional football club.