Question

A software designer has been asked to build a few apps for a start-up company. The company can't pay him a salary but rather will pay him a commission on sales for the smart phone apps that he writes. He will get a 33.00% royalty for his effort. The company has projected that sales will be $84,491.00 next year, and will grow by 3.00% per year after that. The contract will pay the designer for the next 7.00 years. The designer wants an 12.00% return on his investments.

Suppose that the designer invests each cash flow at his desired return, what is the account value at the end of this contract?

Answer 1

Expected Sales = $ 84491, Commission on Sales = Royalty = 33 % = 0.33 x 84491 = $ 27882.03, Sales Growth Rate = Sales Commission growth rate = 3 % (the two rates are equal because the royalty is a fixed % of the sales), Required Return = 12 % and Contract Tenure = 7 Years

Present Value of Royalty over the next 7 years = 27882.03 x [1/(0.12-0.03)] x [1-{(1.03)/(1.12)}^(7)] = $ 137448.3462

Account Value at the end of the contract = Future Value of the sum of present values of royalty compounded at 12% = 137448.3462 x (1.12)^(7) = $ 216277.6338