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 $0.58m now and $194k 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 $206k 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 CASH FLOWS		OFFER 3	HALF YEARLY	HALF YEARLY
	0.909	1	580000	527272.727			2100000	1260000.0	378000.00	343636.364			206000	206000
	0.826	2	580000	479338.843			2940000	1764000.0	529200.00	437355.372			206000	206000
	0.751	3	580000	435762.585			4116000.00	2469600.0	740880.00	556634.110			206000	206000
	0.683	4	580000	396147.804			5762400.00	3457440.0	1037232.00	708443.412			206000	206000
	0.621	5	580000	360134.367					TOTAL	2046069.3			206000	206000
	0.564	6	194000	109507.942									206000	206000
	0.513	7	194000	99552.675									206000	206000
	0.467	8	194000	90502.432									206000	206000
	0.424	9	194000	82274.938								TOTAL	1648000	1648000
	0.386	10	194000	74795.398									`		PRESENT VALUE OF PROCEEDS
	0.350	11	194000	67995.816									COMPOUND PROCEEDS	3296000	1537608.33
	0.319	12	194000	61814.379										3296000*.467
	0.290	13	194000	56194.890
	0.263	14	194000	51086.263
	0.239	15	194000	46442.058
	TOTAL SALES	4840000	2938823.12
		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	2938823.12-1537608.33
				1401214.79
			% DIFF	91.13	MEANS THERE IS 91.13% MORE RETURN IN OFFER I THAN OFFER III
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