Dr. Harold Wolf of Medical Research Corporation (MRC) was thrilledwith the response he had received from drug companies for hislatest discovery, a unique electronic stimulator that reduces thepain from arthritis. The process had yet to pass rigorous FederalDrug Administration (FDA) testing and was still in the early stagesof development, but the interest was intense. He received the threeoffers described below this paragraph. (A 10 percent interest rateshould be used throughout this analysis unless otherwisespecified.)
Offer I $1,000,000 now plus $200,000 from year 6 through 15. Alsoif the product did over $100 million in cumulative sales by the endof year 15, he would receive an additional $3,000,000. Dr. Wolfthought there was a 70 percent probability this would happen.
Offer II Thirty percent of the buyerâs gross profit on the productfor the next four years. The buyer in this case was ZbayPharmaceutical. Zbayâs gross profit margin was 60 percent. Sales inyear one were projected to be $2 million and then expected to growby 40 percent per year.
Offer III A trust fund would be set up for the next 8 years. At theend of that period, Dr. Wolf would receive the proceeds (anddiscount them back to the present at 10 percent). The trust fundcalled for semiannual payments for the next 8 years of $200,000 (atotal of $400,000 per year).
The payments would start immediately. Since the payments are comingat the beginning of each period instead of the end, this is anannuity due. To look up the future value of an annuity due in thetables, add 1 to n (16 + 1) and subtract 1 from the value in thetable. Assume the annual interest rate on this annuity is 10percent annually (5 percent semiannually). Determine the presentvalue of the trust fundâs final value.
Required: Find the present value of each of the three offers andindicate which one has the highest present value.
Dr. Harold Wolf of Medical Research Corporation (MRC) was thrilledwith the response he had received from drug companies for hislatest discovery, a unique electronic stimulator that reduces thepain from arthritis. The process had yet to pass rigorous FederalDrug Administration (FDA) testing and was still in the early stagesof development, but the interest was intense. He received the threeoffers described below this paragraph. (A 10 percent interest rateshould be used throughout this analysis unless otherwisespecified.)
Offer I $1,000,000 now plus $200,000 from year 6 through 15. Alsoif the product did over $100 million in cumulative sales by the endof year 15, he would receive an additional $3,000,000. Dr. Wolfthought there was a 70 percent probability this would happen.
Offer II Thirty percent of the buyerâs gross profit on the productfor the next four years. The buyer in this case was ZbayPharmaceutical. Zbayâs gross profit margin was 60 percent. Sales inyear one were projected to be $2 million and then expected to growby 40 percent per year.
Offer III A trust fund would be set up for the next 8 years. At theend of that period, Dr. Wolf would receive the proceeds (anddiscount them back to the present at 10 percent). The trust fundcalled for semiannual payments for the next 8 years of $200,000 (atotal of $400,000 per year).
The payments would start immediately. Since the payments are comingat the beginning of each period instead of the end, this is anannuity due. To look up the future value of an annuity due in thetables, add 1 to n (16 + 1) and subtract 1 from the value in thetable. Assume the annual interest rate on this annuity is 10percent annually (5 percent semiannually). Determine the presentvalue of the trust fundâs final value.
Required: Find the present value of each of the three offers andindicate which one has the highest present value.
