Question

When purchasing the rights to a royalty, depending on the seller’s desired cash flows, Royalty Pharma can provide different types of payment schedules, such as an accelerated royalty or a synthetic royalty. In an accelerated royalty investment, Royalty Pharma provides the seller with the cash flow from a royalty over a shorter duration than the actual royalty.

For example, suppose the seller agrees to receive a fixed annual payment from Royalty Pharma for three years instead of 3% royalty on net sales over the course of 9 years. Assuming net sales of $1 billion per year, and a discount rate of 10%, what is the minimum acceptable fixed annual payment for this three-year agreement? Assume all cash flows including royalties occur at the end of the year so the first payment is made in exactly 1 year.

Answer 1

Net sales = 1 billion

3% of net sales = 3%*1 billion = 30 million

Calculate the Present Value (PV) of receiving 30 million for 9 years at a discount rate of 10%:

PMT = 30,000,000; N = 9; I/Y = 10%, solve for PV.

PV = 172,770,714.49

This is the PV of the total amount which the seller has to receive. Now, distribute this equally over 3 years at a discount rate of 10%:

PV = 172,770,714.49; N = 3; I/Y = 10%, solve for PMT

PMT = 69,473,661.93

The fixed annual payment for the 3-year agreement should be 69,473,661.93