Question

You have received the following three payment options for a software application you have developed to sell:

Option 1

You will receive $1,000,000 now plus $200,000 from year 6 through 15. Also, if the software application did over $100 million in cumulative sales by the end of year 15, you will receive an additional $3,000,000. There is a 70 percent probability this would happen.

Option 2

You will receive thirty percent of the buyer’s gross profit on the product for the next four years. The buyer’s gross profit margin is 60 percent. Sales in year one were projected to be $2 million and then expected to grow by 40 percent per year.

Option 3

A trust fund would be set up for the next eight years. At the end of that period, you will receive the proceeds (and discount them back to the present at 10 percent). The trust fund called for semiannual payments for the next eight years of $200,000 (a total of $400,000 per year).
The payments would start immediately. The annual interest rate on this annuity is 10 percent annually (5 percent semiannually). Hint: Since the payments are coming at the beginning of each period instead of the end, this is an annuity due.

NOTE: Use a 10 percent interest rate throughout this analysis, unless otherwise specified.

Your task:

A. Determine the present value of each of the payment options. You must show the details

of your work to receive credit (3 points for each option)

B. Create a bar graph in Excel that clearly shows the three options’ present values.

C. Explain the best payment option in one sentence (3 points)

Answer 1

PART ;-A)
Present Value of Payment Option #1
PV= Present Value
PVIF= Present value of Interest Factor
PVIAF= Present value of Annuity Factor
Interest Rate = 10%
Year	Probability (a)	Amount(b)	PVIF @10% ©	PV (a*b*c)
0	1	$             1,000,000	0.909090909	$      909,090.91
6	1	$             2,000,000	0.513158118	$ 1,026,316.24
15	0.7	$             3,000,000	0.122845974	$      257,976.54
				$ 2,193,383.69
Present Value of Payment Option #1= $2,193,383.69
Present Value of Payment Option #2
Year	Sales (a)	Gross Margin(b)= (a*60%)	Amount ©=(b*30%)	PVIF @10% (d)	PV (d*c)
1	$          2,000,000	$         1,200,000.0	$      360,000.0	0.909090909	$      327,272.73
2	$       2,800,000.0	$         1,680,000.0	$      504,000.0	0.826446281	$      416,528.93
3	$       3,920,000.0	$         2,352,000.0	$      705,600.0	0.751314801	$      530,127.72
4	$       5,488,000.0	$         3,292,800.0	$      987,840.0	0.683013455	$      674,708.01
5	$       7,683,200.0	$         4,609,920.0	$ 1,382,976.0	0.620921323	$      858,719.29
6	$    10,756,480.0	$         6,453,888.0	$ 1,936,166.4	0.56447393	$ 1,092,915.46
					$ 3,900,272.13
Present Value of Payment Option #2= $3,900,272.13
Present Value of Payment Option #3
PV= $200,000 + $200,000 *PVAF (5%, 15)
PVAF (5%, 15) = 10.37966
therefore PV= $200,000 + $200,000*10.37966 = $2,275,932
Present Value of Payment Option #3= $2,275,932
PART ;-B)
Option	Payment
1	$    2,193,383.69
2	$    3,900,272.13
3	$    2,275,932.00
PART ;-C)
The best payment option is the 2nd option, as it involve highest cash inflow to us.