Question

Toselli Animation plans to offer its employees a salary enhancement package that has revenue sharing as its main component. Specifically, the company will set aside 2% of total sales revenue for year-end bonuses. The sales are expected to be $5 million the first year, $5.5 million the second year, and amounts increasing by 10% each year for the next 5 years. At an interest rate of 5% per year, what is the equivalent annual worth in years 1 through 5 of the bonus package? The equivalent annual worth of the bonus package is $

Answer 1

The company will set aside 2% of total sales revenue for year-end bonuses

1^st year sales = $5,000,000 and it increases by 10% every year

2% of $5,000,000 = $100,000 will be the set aside amount in the 1^st year

As the sales is increasing by 10% every year, the 2% amount set aside by the company is also increases by 10% every year.

Rate of interest = 5%

Time period = 5 years

Calculate the equivalent annual worth

This is the case of geometric gradient cash flow. In this case we have to calculate the PW and they it can be converted into annual worth.

Now calculate the Present value first

A1 = $100,000, G = 10%, n = 5 years, I = 5%

Present Value = A1 [1 – (1+g) ^N (1+i) ^–N ÷ i – g]

Present Value = $100,000 [1 – (1+0.10) ⁵ (1+0.05) ^–5 ÷ 0.05 – 0.10]

Present Value = $100,000 (5.23753452718) = $523,753

Annual Worth = PW (A/P, 5%, 5)

Annual Worth = $523,753 (0.2310)

Annual Worth = $120,986.94 OR $120,987

The equivalent annual worth of the bonus package is $120,987.