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 $0.5m now and $190k 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 $207k 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	540000	490909.09			2000000	1200000.0	360000.00	327272.727			207000	207000
	0.826	2	540000	446280.99			2800000	1680000.0	504000.00	416528.926			207000	207000
	0.751	3	540000	405709.99			3920000.00	2352000.0	705600.00	530127.724			207000	207000
	0.683	4	540000	368827.27			5488000.00	3292800.0	987840.00	674708.012			207000	207000
	0.621	5	540000	335297.51					TOTAL	1948637.4			207000	207000
	0.564	6	190000	107250.05									207000	207000
	0.513	7	190000	97500.04									207000	207000
	0.467	8	190000	88636.40									207000	207000
	0.424	9	190000	80578.55								TOTAL	1656000	1656000
	0.386	10	190000	73253.22									`		PRESENT VALUE OF PROCEEDS
	0.350	11	190000	66593.84									COMPOUND PROCEEDS	3312000	1545072.44
	0.319	12	190000	60539.86										3312000*.467
	0.290	13	190000	55036.23
	0.263	14	190000	50032.94
	0.239	15	190000	45484.49
		TOTAL SALES	4600000	2771930.48
		LEAST OPTION IS OPTION 3RD
	1	% DIFFERENCE BETWEEN OFFER 1 TO OFFER 3
		DIFFERENCE AMOUNT	2771930.48-1545072.44
				1226858.03
				79.40	MEANS THERE IS 79.4% MORE RETURN IN OFFER I THAN OFFER III
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