Question

Dr. Harold Wolfe of Medical Research Corporation (MRC) was thrilled with the response that he had received from the medical community for his latest discovery, a unique electronic stimulator that reduces the pain from arthritis. Although the device has yet to receive FDA approval, early stage clinical trials have been deemed a tremendous success. Several medical device companies have expressed intense interest in partnering with Dr. Wolfe in the distribution of his device once full approval has been granted.

So confident are these medical device distributors in the success of his new invention, Dr. Wolfe has offers from three different companies relating to a partnership for the sale of his device to patients and hospitals. These three offers are detailed below. In any event, these types of medical devices typically have a lifespan of about 10 years before the next revolutionary product is developed. As such, all three offers are for a term of ten years from today.

Recognizing that this may be his best, and perhaps, only shot at monetizing years of research and development, Dr. Wolfe wants to be absolutely sure that he makes the best deal for himself. Also keenly aware of the risks involved in the medical device industry, Dr. Wolfe believes that a 10% discount rate is appropriate for this decision.

Offer 1

Zbay Pharmaceuticals has offered Dr. Wolfe a payment of $1 million today, plus $200,000 at the end of years 6 through 10.

Offer 2

Traxis Health, Inc. is offering Dr. Wolfe 9 payments of $250,000 per year, with the first payment being made 1 year from today. Additionally, at the end of year 10, Dr. Wolfe will receive a final payment of $2 million.  

Offer 3

Ipscar Medical Manufacturing is offering a unique payment arrangement. Ipscar will make 10 deposits of $400,000 each into a trust fund. The first of these deposits will be made 1 year from today. At the end of the 10^th year, Dr. Wolfe will receive the proceeds of the trust fund. Once each deposit is made into the trust fund, these funds will earn interest of 10% per year until the end of year 10.

Dr. Wolfe has asked for your assistance in making the most economical decision. He will need a quick response as he has until the end of the day to sign a contract with one of the distributors.

1. Describe what offer is best to recommend. That is, what criteria will you use to determine the most attractive offer? Give supporting evidence to show why.

Answer 1

Criteria we use to determine the most attractive offer will be to find out the present values of the three offers & compare & select the highest paying offer.

Accordingly,

Offer 1---Zbay Pharmaceuticals

PV of the offer=1000000+(200000/1.1^6)+(200000/1.1^7)+(200000/1.1^8)+(200000/1.1^9)+(200000/1.1^10)=

1470756

Offer 2 ---Traxis Health Inc.

PV of this offer=(PV of 9 nos. year-end ordinary annuities of $ 250000 discounted at 10%)+(PV of a single payment of $ 2000000 at yr. 10)

ie. (250000*(1-1.1^-9)/0.1)+(2000000/1.1^10)=

2210843

Offer 3---Ipscar Medical Manufacturing

PV of this offer=PV of 10 nos. ordinary year-end annuities of $ 400000 each, at 10%

ie. 400000*(1-1.1^-10)/0.1

2457827

Offer--3 (Ipscar Mfg.) is RECOMMENDED for its highest PV