Dr. Harold Wolf of Medical Research Corporation (MRC) was thrilled with the response he had received from drug companies for his latest discovery, a unique electronic stimulator that reduces the pain from arthritis. The process had yet to pass rigorous Federal Drug Administration (FDA) testing and was still in the early stages of development, but the interest was intense. He received the three offers described in the following paragraph. (A 10 percent interest rate should be used throughout this analysis unless otherwise specified.) Page 287 Offer I $1,000,000 now plus $200,000 from year 6 through 15. Also if the product did over $100 million in cumulative sales by the end of year 15, he would receive an additional $3,000,000. Dr. Wolf thought there was a 70 percent probability this would happen. Offer II Thirty percent of the buyer's gross profit on the product for the next four years. The buyer in this case was Zbay Pharmaceutical. Zbay's gross profit margin was 60 percent. Sales in year 1 were projected to be $2 million and then expected to grow by 40 percent per year. Offer III A trust fund would be set up for the next eight years. At the end of that period, Dr. Wolf would 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. Since the payments are coming at the beginning of each period instead of the end, this is an annuity due. Assume the annual interest rate on this annuity is 10 percent annually (5 percent semi-annually). Determine the present value of the trust fund's final value. Hint: See the section "Annuities Due @." Required: Find the present value of each of the three offers and indicate which one has the highest present value.
Dr. Harold Wolf of Medical Research Corporation (MRC) was thrilled with the response he had received from drug companies for his latest discovery, a unique electronic stimulator that reduces the pain from arthritis. The process had yet to pass rigorous Federal Drug Administration (FDA) testing and was still in the early stages of development, but the interest was intense. He received the three offers described in the following paragraph. (A 10 percent interest rate should be used throughout this analysis unless otherwise specified.) Page 287 Offer I $1,000,000 now plus $200,000 from year 6 through 15. Also if the product did over $100 million in cumulative sales by the end of year 15, he would receive an additional $3,000,000. Dr. Wolf thought there was a 70 percent probability this would happen. Offer II Thirty percent of the buyer's gross profit on the product for the next four years. The buyer in this case was Zbay Pharmaceutical. Zbay's gross profit margin was 60 percent. Sales in year 1 were projected to be $2 million and then expected to grow by 40 percent per year. Offer III A trust fund would be set up for the next eight years. At the end of that period, Dr. Wolf would 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. Since the payments are coming at the beginning of each period instead of the end, this is an annuity due. Assume the annual interest rate on this annuity is 10 percent annually (5 percent semi-annually). Determine the present value of the trust fund's final value. Hint: See the section "Annuities Due @." Required: Find the present value of each of the three offers and indicate which one has the highest present value.
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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Transcribed Image Text:Dr. Harold Wolf of Medical Research Corporation (MRC) was thrilled with the response he had received from drug companies for
his latest discovery, a unique electronic stimulator that reduces the pain from arthritis. The process had yet to pass rigorous Federal
Drug Administration (FDA) testing and was still in the early stages of development, but the interest was intense. He received the
three offers described in the following paragraph. (A 10 percent interest rate should be used throughout this analysis unless
otherwise specified.)
Page 287
Offer I
$1,000,000 now plus $200,000 from year 6 through 15. Also if the product did over $100 million in cumulative
sales by the end of year 15, he would receive an additional $3,000,000. Dr. Wolf thought there was a 70 percent
probability this would happen.
Thirty percent of the buyer's gross profit on the product for the next four years. The buyer in this case was Zbay
Pharmaceutical. Zbay's gross profit margin was 60 percent. Sales in year 1 were projected to be $2 million and
Offer II
then expected to grow by 40 percent per year.
Offer III
A trust fund would be set up for the next eight years. At the end of that period, Dr. Wolf would 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. Since the payments are coming at the beginning of each period instead of
the end, this is an annuity due. Assume the annual interest rate on this annuity is 10 percent annually (5 percent
semi-annually). Determine the present value of the trust fund's final value. Hint: See the section
"Annuities Due ."
Required: Find the present value of each of the three offers and indicate which one has the highest present value.
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