Question

The research group at Company A developed a patent that is anticipated to bring in $550,000 in royalty income each of the next n years. Company B has expressed interest in buying the rights to the patent, and CA is asking $2.5 million. If interest is 8% compounded annually, how many years do the royalties need to last for it to be profitable for Company B to purchase the rights today?

Answer 1

Company B shall receive the royalty for atleast 6 years as is to make the purchase of rights profitable.

Explanation is as follows:

Year	Cash flows	PVF @ 8%	Present value		Cumulative Present value
0	-2,500,000	1	-2500000		-2500000
1	550,000	0.925926	509259.3		-1990741
2	550,000	0.857339	471536.4		-1519204
3	550,000	0.793832	436607.7		-1082597
4	550,000	0.73503	404266.4		-678330
5	550,000	0.680583	374320.8		-304009
6	550,000	0.63017	346593.3		42583.82
7	550,000	0.58349	320919.7		363503.5
8	550,000	0.540269	297147.9		660651.4
9	550,000	0.500249	275136.9		935788.4

Note: The Year in which the cumulative Present value of cash flows become positive is the year in which the project is running in to profits. Hence, as seen from above table, the cumulative present values is positive in Year-6. therefore, Company B shall receive the Royalty for atleast 6 years.