Question

Consider the following investment offers regarding a product you have recently developed. A 10% interest rate should be used throughout this analysis unless otherwise specified:

Offer (I) – Receive $0.48m now and $196k from year 6 through 15. Also, if your product achieved over $100 million in cumulative sales by the end of year 15, you would receive an additional $3m. Assume that there is a 70% probability this would happen.

Offer (II) – Receive 30% of the buyer’s gross profit on the product for the next 4 years. Assume that the buyer’s gross profit margin is 60%. Sales in year 1 are projected to be $2.1m and then expected to grow by 40% per year.

Offer (III) – A trust fund would be set up, calling for semiannual payments of $201k for 8 years. On the 17th period, you would receive the compounded proceeds, which would then be discounted over the 8-year period back to the present at the specified annual rate.

Note: The term “k” is used to represent thousands (× $1,000).

Required: Determine the percentage difference between your most and least profitable alternatives, with the least profitable option as the basis for your calculation.

Answer 1

Solution:-

Given that,

The following investement offers regarding a product you have recently developed.A 10% interest rate should be used throught this analysis unless otherwise specified.

Offer I

Present value of the offer =

=$1730520.6801

Offer II

Amount received after one year = $2100000*60%*30% =$378000

Present value of the offer = 378000/1.1+378000*1.4/1.1^2+378000*1.4^2/1.1^3+378000*1.4^3/1.1^4

=$2046069.2575

Offer III

Present value of the offer =

=

=$2196979.04

The most profitable option is Option IIII and the least one is Option I

% difference = (2196979.04-1760520.68)/1760520.68 = 0.2479 or 24.79%