The Phoenix Kings of the United Basketball League have a moody center by the name of Orlando Dawkins. Dawkins is under contract with the team and is scheduled to earn $650,000 in both 20X3 and 20X4. A $75,000 salary increase will take effect in 20X5.
Dawkins has not gotten along with several of his teammates and, as a result, management is exploring the possibility of a trade with the Philadelphia Rockets to acquire George Harper, a star player. The Kings would pay the Rockets $350,000 immediately for the trade to take place. Harper would be paid a $270,000 signing bonus at the beginning 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 20X3 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 would play 3 more years for the Kings, at which time they would become free agents and move along to other clubs. The Kings would receive $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 the end of 20X4 under the terms of his original contract.
The Kings desire a rate of return of 14% and use the net present value method to analyze investments. Round all calculations to the nearest dollar, and ignore income taxes.
1. Determine whether the Kings should keep Dawkins or trade for Harper. Assume the trade would occur on January 1, 20X3.
2. Future cash flows are, in many cases, subject to change. List several events that could occur that might influence the cash flows in this situation.