Question

In: Accounting

Consider the following investment offers regarding a product you have recently developed. A 10% interest rate...

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 $0.51m now and $199k 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 $2m and then expected to grow by 40% per year.

Offer (III) – A trust fund would be set up, calling for semiannual payments of $208k 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.

Solutions

Expert Solution

OFFER 1 PRESENT VALUE OF 1 @10% YEAR CASH FLOW PRESENT VALUE OF CASH FLOWS OFFER 2 SALES MARGIN 60% PROFIT 30% OF MARGIN (CASH FLOWS) PRESENT VALUE OF CSH FLOWS OFFER 3 HALF YEARLY HALF YEARLY
0.909 1 510000 463636.364 2000000 1200000.0 360000.00 327272.727 208000 208000
0.826 2 510000 421487.603 2800000 1680000.0 504000.00 416528.926 208000 208000
0.751 3 510000 383170.548 3920000.00 2352000.0 705600.00 530127.724 208000 208000
0.683 4 510000 348336.862 5488000.00 3292800.0 987840.00 674708.012 208000 208000
0.621 5 510000 316669.875 TOTAL 1948637.4 208000 208000
0.564 6 199000 112330.312 208000 208000
0.513 7 199000 102118.466 208000 208000
0.467 8 199000 92834.969 208000 208000
0.424 9 199000 84395.426 TOTAL 1664000 1664000
0.386 10 199000 76723.115 ` PRESENT VALUE OF PROCEEDS
0.350 11 199000 69748.286 COMPOUND PROCEEDS 3328000 1552536.56
0.319 12 199000 63407.533 3328000*.467
0.290 13 199000 57643.212
0.263 14 199000 52402.920
0.239 15 199000 47639.018
TOTAL SALES 4540000 2692544.51
THE LEAST PROFITABLE OPTION IS OFFER III
AND THE MOST PROFITABLE OPTION IS OFFER I
1 % DIFFERENCE BETWEEN OFFER 1 TO OFFER 3
DIFFERENCE AMOUNT 2692544.51-1552536.56
1140007.95
% DIFF 73.43 MEANS THERE IS 73.43% MORE RETURN IN OFFER I THAN OFFER III

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