TVM And Max Scherzer

The time value of money is everywhere and when you see large cash flows over many years, you need to be careful about the reported values. Consider the analysis of Max Scherzer’s contract, which was stated as having a $210 million value. Even though Scherzer would pitch for only seven years under the contract, he would receive $15 million per year for 14 years. At a 7 percent discount rate, the present value of the contract is only $131 million. A more typical contract, with the salary increasing over seven years, would result in a present value of $158 million, and an equal annual salary of $30 million would result in a present value of $162 million. That’s quite a disparity in values. And, while we agree with the calculations, we aren’t convinced that the seven percent rate being used as a proxy for the long-term return on the stock market isn’t a bit low.

A Fantastic NPV

One thing you should always consider is the reasonableness of any estimate. For example, Hycroft Mining recently announced that a gold mine the company on which the company has begun work has an NPV of $2.1 billion with an initial investment of $61 million! The project has an IRR of 147 percent and a profitability index of more than 34 times. While this certainly seems to be a fantastic project, we have some doubts about the extremely high NPV and IRR estimates. We would also mention that the discount rate of 5 percent, which was used by the company, seems low for a project of this risk. The stock market doesn’t believe the NPV of this mine is anywhere near $2.1 billion: The company’s current market capitalization is about $5 million.

The Power Of Compounding

We hope you have learned about the power of compounding by now. If not, consider your future retirement. How much of your salary do you need to save in order to replace your pre-retirement income? Somewhere between 4 and 44 percent of your salary! If you start saving at 25 and retire at 70, you only need to save 4 percent of your salary, but if you wait to start saving until you are 45 and want to retire at 62, you will have to save 44 percent of your salary. That is quit a big difference and shows the power of compounding.

Beer Bonds

Bonds do not necessarily have to pay cash coupons. A bond by Scottish brewery BrewDog highlights this point. BrewDog is considering a new bond issue that would have a 6 percent coupon, paid out as 3 percent in cash and 3 percent in craft beer. If you have buy one of these bonds, you would get a cash payment, a coupon for £20 in BrewBucks redeemable at the company's bars, a free book, and a free beer on your birthday each year you are a bondholder. Cheers! 

The Popularity of BBB Bonds

S&P, one of the major bonds rating agencies, has categorized bonds by credit ratings, and BBB bonds compose the largest chunk of corporate bonds. BBB bonds account for $3.2 trillion, or 53 percent of the outstanding investment grade bonds. Total BBB corporate debt, including term loans and revolving credit facilities, tops $7 trillion. One risk with this much debt just above the junk level is that an economic downturn could result in a large part of this debt being downgraded to junk status.