The Phoenix Kings of United Basketball League have a moody center by name of Orlando Dawkins. Dawkins is under contract with team and is listed to earn $650,000 in both 20X3 and 20X4. A $75,000 salary increase can take effect in 2005.
Dawkins has not gotten along with some of his teammates and, as a result, management is exploring the possibility of a trade with Philadelphia Rockets to get George Harper, a star player. The Kings would pay the Rockets $350,000 immediately for the trade to take place. Harper could be paid a $270,000 signing bonus at the starting of 20X3 that management plans to expense over the next 3 years by using straight-line amortization. Harper's annual salary would be $950,000 from 2003 through 20X5, highest on the team because of his ability to attract fans. The Kings expect that increased attendance will produce added annual net cash inflows of $525,000.
Phoenix officials believe that both players could play 3 more years for the Kings, at which time they would become free agents and move along to other clubs. The Kings would get $380,000 compensation from the other club for Dawkins; for Harper, the figure would increase to $500,000. Regardless of whether the trade takes place, the Kings are obligated to pay Dawkins $200,000 at end of 20X4 under the terms of his original contract.
The Kings desire a rate of return of 14 percent and use the net present value method to examine investments.
1. Evaluate whether the Kings should keep Dawkins or trade for Harper . Imagine the trade would occur on 1st January, 20X3.
2. Future cash flows are, in many cases, subject to change. List various events that could occur that might influence the cash flows in situation.