Division II to Division I

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Maximilian Jefferson
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1 Division II to Division I Situation Analysis Dr. Keldon Bauer, Head Accounting, Finance and Economics Department Tarleton State University (discussion draft of ) Philosophy: Typically, financial analysts would use capital budgeting techniques to analyze a project such as the proposed plan to move from NCAA Division II to Division I. But there are at least two problems with using traditional capital budgeting techniques in this situation. First, capital budgeting assumes that the objective of the organization is to maximize owner wealth. In the case of non-profit or government institutions, that assumption is violated. Second, capital budgeting requires a cost of capital. The cost of capital is a weighted average of all sources of capital. These concepts are extremely problematic in the case of non-profits and even more problematic with state institutions. If we break down the methodology of capital budgeting, we can consider whether the benefits expected from a capital project are worth the cost of the investment. In any case, we must only consider incremental costs (investments) and benefits. Whenever possible, we will try to take into consideration the time value of money. To proceed, we need the following information: 1. A listing of potential benefits from the move from Division II to Division I. 2. Incremental costs of moving from Division II to Division I. Incremental costs are additional costs expected, above what would happen if the project were not adopted. That means that it is critical to identify cost increases associated with moving to D I, if any, versus what those costs would be if the university remained in Division II. 3. Opportunity cost of investment funds. If this project were not adopted, what is the return the institution should expect from those same funds. Benefits: Although many people look at Division I athletics as enhancing the entertainment available to students, faculty and the community, the primary benefits accruing to the university from the sports economics literature could probably be summarized as an enhancement in the awareness of the university, and the strengthening of its brand identity. This benefit impacts the university in two important ways. First, enhanced awareness of the university moves the demand for education services to the right (see Sandy and Sloane, 2004). That means the university should have more applications for admissions, meaning more students willing to come to the university (Perez, 2012; and Pope and Pope, 2014). The university can either simply increase the number of students entering the university (holding entrance requirements constant), increase the entrance requirements of the university while maintaining the same number of students, or finding a new equilibrium with a combination of slightly higher student body and slightly higher entrance requirements. The second way improved awareness affects the university is through increases in donations to the institution not just to athletics, but also to the academic side of the institution (see Walker, 2015; and Holmes, Meditz and Sommers, 2008). The enhanced awareness, and strengthened brand identity Division II to Division I 1 Situation Analysis

2 makes all donors more aware of the university. It also positively affects their image of the strength of the university in all fields, leading to higher levels of donations in all fields not just athletics. Although these two benefits are well documented in the literature, no one at the university ever feels comfortable estimating these figures. For instance, I have heard that the university is trying to grow its student body by 3% per year. Any growth in demand above that would be used to enhance the entrance requirements. I don t know whether those figures are correct (especially with the Fort Worth campus scheduled to come online soon). But I have yet to have anyone articulate such a strategy so that meaningful projections can be built. Similar vagueness exists around the strategies of the development efforts of the university, making it nearly impossible to even guesstimate what the possible impact of such a move would be to the success of capital campaigns. It should be noted that even though the benefits are well documented for the university, the benefits to the local economy are a little more tentative (see Baade, Baumann and Matheson, 2008). Incremental Costs: In an attempt to get at incremental costs of the move from Division II to Division I, I started with the work that had already been done by Collegiate Consulting as well as a Transition Plan written by Tarleton State University Athletic Director, Lonn Reisman. Each of these sources has advantages and disadvantages. The Collegiate Consulting report was in an in depth report, but is now dated. It was completed in 2014, and I have been told that some of the facts are no longer true (e.g. no additional sports are required to qualify Tarleton State for acceptance into Division I, and the application fee has increased to $1.61 million just to name two key issues). The Transition Plan by Lonn Reisman is up-to-date, but has some internal inconsistencies. The greatest advantage to the Transition Plan is that its author is accessible here on campus. So we scheduled some time with Mr. Reisman to try to flesh out a reasonable financial plan under four scenarios. Over three or four one hour sessions with Mr. Reisman, we developed four scenarios for Tarleton State University Athletics Department. Three of the four scenarios represented total budget estimates for what we called worst case, base case and best case scenarios under Division I. Unlike for-profit businesses, where each of these scenarios would represent increasing profits; in our scenarios, the cases represented increasing success on the sports field and by extension improved brand/image improvement. It should be noted before displaying these scenarios that the actual net revenues decline slightly as we move from worst case up to best case. It should also be noted that the literature is clear that a successful athletics program depends on having enough money to be successful (see Willis, 2013), and that the more success an athletics program has, the more it benefits the non-athletic side of the university (see Perez, 2012; and Pope and Pope, 2014). The fourth scenario represented what the budget would have to look like to maintain our position in Division II athletics. Too often we assume that it would look like it did last year, but that is certainly not the case in this analysis. Programs will still need to be developed. And more importantly the Division II conference is changing in such a way that the travel budget for Division II will actually be larger than under Division I (assuming the university entered the Southland conference), since the schools in the university s current Lone Star Division II conference are scattered more widely than in the Southland Conference of Division I. Since I don t work in Business Services, I used Mr. Reisman s base budget as my own base, and I assumed that the Division I conference to which we were invited was the Southland Conference. Based on those assumptions the baseline Athletics budget under a Division II scenario is presented at the top of the next page. In order to make any of the scenario budgets balance, we needed to increase funding. The source of the funding that was increased in all scenarios is simply the doing away with the waiver currently in place for students in locations other than Stephenville. Since the key benefits identified thus Division II to Division I 2 Situation Analysis

3 far in this report accrue to all students, it makes no sense that only Stephenville students pay the fee. It is unclear exactly how much this added fee would enhance the current revenue, but it appears to be in the neighborhood of $1.4 million this year. In the budgets that follow, it is assumed to grow at 3% per year to represent increased enrollment only (although I would suggest that the fee also be indexed to inflation). This budget is actually conservative in that the travel budget was not adjusted upward under Division II, despite the fact that it will almost certainly go higher. Mr. Reisman does not yet have a good grasp on how much higher that figure will go under the ever expanding number of schools in the Lone Star Conference, and as yet no word on how the conference will be subdivided for competition. The Division II External Revenues 725, , , , , ,801 Budgeted Expenses 7,531,661 8,054,721 8,409,771 8,934,863 9,294,418 9,666,738 Net Revenues - 1,199,804 1,109, , , ,480 Athletic Department budget (with this year being the baseline) would appear as follows: Worst Case Scenario - Division I External Revenues 725,070 1,595,056 2,116,940 2,431,488 2,694,580 2,881,577 Budgeted Expenses 7,531,661 8,575,482 9,260,690 10,417,147 10,868,826 11,366,265 Net Revenues - 1,430,363 1,519, ,347 1,016, ,729 Division II to Division I 3 Situation Analysis

4 Base Case Scenario - Division I External Revenues 725,070 1,692,633 2,221,726 2,544,403 2,816,187 3,013,705 Budgeted Expenses 7,531,661 8,753,815 9,560,599 10,662,609 11,226,674 11,854,628 Net Revenues - 1,349,607 1,324, , , ,494 Best Case Scenario - Division I External Revenues 725,070 1,791,115 2,318,802 2,640,422 2,910,710 3,108,745 Budgeted Expenses 7,531,661 9,111,217 9,939,499 10,843,990 11,494,063 12,217,181 Net Revenues - 1,090,687 1,042, , , ,980 Again, note that the scenarios (worst, base, and best case) are all under Division I. They were developed as a way of exploring how Mr. Reisman would adjust his budgets for changes in funding environments. The amount of money expended increased as we moved from worst to best case scenario, and the image/brand enhancement increased though the net revenue decreased. It is further worth noting that these are not likely the only costs that would increase under the move to Division I, but these would be the largest sustained expenses. Other expenditures that would need to be made would include perhaps more money required for the marching band, and certainly more investment in communication equipment to enable instant replay (which is required at the Division I level but not at Division II). Under any of the above scenarios, an increase in student fees could handle some increased cost over the first year. However, I would recommend scaling back any financial commitment for that investment until after the development office can see what they can raise for those start-up costs. Division II to Division I 4 Situation Analysis

5 Opportunity Costs: Ideally, a capital budgeting project will have a cost of capital or an opportunity cost expressed as a percent. That opportunity cost represents the next best opportunity where those funds could be employed. In a state university setting, such a cost of capital is hard to come by. Some researchers have proposed how to employ capital budgeting and cost of capital. However, these same procedures seem tortured, and unnatural in their application. Once I got to this position in the analysis, my question was whether or not the incremental change in investment by our students (the source of the fee revenue) would be worth the initial investment. In essence, the approach could be akin to taking the projects internal rate of return (IRR). However, all benefits have not been well defined. The one thing that does seem clear from the cash flow estimates as outlined above is that the incremental costs are nearly non-existent (except for the application fee and the instant replay equipment). Because of the game guarantees, and other revenues that would accrue under the Division I scenarios (which don t exist or are much reduced under Division II), the move to Division I athletics does not appear to cost any more out of pocket than Division II. Therefore, the real question is: What is the probability that the discounted value of an annuity (or perpetuity) of higher brand/image enhancements would be higher than out of pocket application fee and communication equipment? Some Conclusions: Based on the financial projections provided by Lonn Reisman, it appears that the only financial difference between Division I and Division II is the application fee (plus any instant replay costs for the stadium). So the real question for decision makers at Tarleton State University is whether or not the benefits over the life of the project are worth the initial investment of $1,600,000. It is as yet unclear how much of these costs can be covered by increased donations. Changes in sports conferences tend to change behaviors of fans in positive ways (see Groza 2010). Many of the benefits that college athletics offers are sought after by all universities. We hire marketing and public relations departments to try to achieve what intercollegiate athletics can achieve by itself. The decision makers at Tarleton State University must simply determine whether the longterm benefit to the university of having Division I athletics is worth the initial outlay as described in this report. Division II to Division I 5 Situation Analysis

6 References: Baade, Robert A.; Baumann, Robert W.; Matheson, Victor A. (2008). Assessing the Economic Impact of College Football Games on Local Economies. Journal of Sports Economics, Vol. 9, No. 6, Groza, Mark D. (2010). NCAA Conference Realignment and Football Game Day Attendance. Managerial and Decision Economics, Vol. 21, Holmes, Jessica A.; Meditz, James A.; and Sommers, Paul M. (2008). Athletics and Alumni Giving: Evidence from a Highly Selective Liberal Arts College. Journal of Sports Economics, Vol. 9, No. 5, Jones, Willis A. (2013). Exploring the Relationship Between Intercollegiate Athletic Expenditures and Team On-Field Success Among NCAA Division I Institutions. Journal of Sports Economics, Vol. 14, No. 6, Perez, Stephen J. (2012). Does Intercollegiate Athletics Draw Local Students to a University? Journal of Sports Economics, Vol. 13, No. 2, Pope, Devin G.; Pope, Jaren C. (2014). Understanding College Application Decisions: Why College Sports Success Matters. Journal of Sports Economics, Vol. 15, No. 2, Sandy, Robert and Sloane, Peter (2004). Why Do U.S. Colleges Have Sports Programs? {Chapter 6 in} Fizel, J., & Fort, R. D. Economics of College Sports. Westport, CT: Praeger. Walker, Adam G. (2015). Division I Intercollegiate Athletics Success and the Financial Impact on Universities. Sage Open, Vol. 5, No. 4 (October December), Division II to Division I 6 Situation Analysis

Financial Ratios and Trends

Financial Ratios and Trends Financial s and Trends (2011 2016) Mississippi Institutions of Higher Learning Office of Finance and Administration 3825 Ridgewood Road, Jackson, Mississippi 39211 (601) 432-6316 Are resources sufficient