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 $0.51m 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.

Answer 1

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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