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 31.00% royalty for his effort. The company has projected that sales will be $88,304.00 next year, and will grow by 3.00% per year after that. The contract will pay the designer for the next 5.00 years. The designer wants an 7.00% 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 = $ 88304, Commission on Sales = Royalty = 31 % = 0.31 x 88304 = $ 27374.24,Sales Growth Rate = Sales Commission growth rate = 3 % (the two rates are equal because the royalty is a fixed % of the sales), Required Return = 7 % and Contract Tenure = 5 Years

Therefore, Contract Value today = Sum of Present Value of Royalty over the next 7 years = 27374.24 x [1/(0..07-0.03)] x [1-{(1.03)/(1.07)}^(5)] = $ 118704.0165

Future Value of Account = Present Value Compounded at 7% = 118704.0165 x (1.07)^(5) = $ 166488.524