The True Cost of Extending

Christopher Reina, executive editor of RealGM, published this article yesterday – suggesting that free agency will cost each member of Wade/James/Bosh trio millions of dollars.

Huh?

If it didn’t shock the heck out of you, it should have. Because it’s wrong!

The minute Wade becomes a free agent, deciding against exercising his player option with the Heat in order to sign an extension, he will be leaving money on the table. This is true. But only in the first year, and only in the amount of $580,335. Every year thereafter, this number begins to shrink. Until year four, when it vanishes completely.

There is no mysterious $1.9 million cost. It doesn’t exist. Forget you ever read it.

I’m guessing most of you don’t care why. But if you’re curious, click away…

1. NEW CONTRACT

By now, just about all of us who care to know how to calculate how much Dwyane Wade is eligible to earn next season if he chooses to opt out of his contract can already do so.

In the first season of his new contract, Wade would be eligible to receive the greater of: (i) a 5% raise from the previous season and (ii) given that he has between 7 and 9 years tenure in the league, 30% of next season’s salary cap. No matter what the salary cap realistically ends up being (current estimates are $56.1 million), the 5% raise will always be bigger. Therefore, in the first season of a new contract, Wade can make up to $16,568,908.

If he signs with the Heat, he would be eligible for annual, non-compounding raises of 10.5% for five additional seasons. If he signs with any other team, he would be eligible for annual, non-compounding raises of 8.0% for four additional seasons.

Decline Player Option, Re-Sign With Heat
10-11: $16,568,908
11-12: $18,308,643
12-13: $20,048,379
13-14: $21,788,114
14-15: $23,527,850
15-16: $25,267,585
Six-Year Total: $125,509,479
Six-Year Average: $20,918,247

Five-Year Total: $100,241,894
Five-Year Average: $20,048,379

Sign With Any Other Team
10-11: $16,568,908
11-12: $17,894,421
12-13: $19,219,933
13-14: $20,545,446
14-15: $21,870,959
Five-Year Total: $96,099,667
Five-Year Average: $19,219,933

2. EXTENSION

Extensions, on the other hand, are quite a bit more complicated than Chris has accounted for.

Contracts may be extended for up to five total seasons, including the seasons remaining on the current contract. Wade still has one more season remaining on his contract, at $17,149,243, which he can opt out of if he so chooses.

The first question is whether he would be required to exercise his option in order to extend his contract. A contract can only be extended following the non-exercise of an option if the player receives no less than he would have received in his option year had it been exercised. We already know from above that Wade can earn a maximum of $16,568,908 if he opts out. Since this number is less than $17,149,243, the answer is yes. Wade would be required to exercise his option if he wants to sign an extension.

The second question is how to calculate the values of each of the remaining four seasons. Well, the salary in the first season of the extended term is limited to 110.5% of the salary in the last season of the existing contract. However, it also can’t exceed the maximum salary the player can receive if he were to sign a new contract that season as a free agent. Putting this concept into a mathematical formula would mean that Wade is eligible to earn up to the following amount in 2011/12:

the minimum of:
(i) $17,149,243 * 110.5%, and
(ii) maximum of: (a) $17,149,243 * 105% and (b) 30% of the 2011/12 salary cap

Raises in each year of an extension are limited to 10.5% of the salary in the last year of the existing contract.

Chris has utilized the first part of this equation, but has neglected to incorporate the second part. In order for the extension numbers he has presented to be correct, the 2011/12 salary cap would need to reach approximately $66.7 million.

That’s ridiculous. There’s no way the cap will jump from $56 million this coming season to $67 million the season after. The more likely scenario, under any normal circumstance, would be as follows (which will be finalized when the 2011 salary cap is determined):

Accept Player Option, Extend With Heat
10-11: $17,149,243
11-12: $18,006,705
12-13: $19,807,376
13-14: $21,608,046
14-15: $23,408,717
Five-Year Total: $99,980,087
Five-Year Average: $19,996,017

The numbers say it all. There’s no way that any one of James, Wade or Bosh will choose to extend his contract. Free agency is the only way to fly.

Note: The league uses a different cap calculation to determine maximum salaries, which is based on 48.04% of Projected BRI.