Alla Aeroshoes is in the business of designing and manufacturing running shoes f

Question

Alla Aeroshoes is in the business of designing and manufacturing running shoes for long distance runners. They are considering a dollar 100 million upgrade to their production line for the iPhone/iPad/iWatch connected shoe that has Bluetooth connectivity. The potential cash flow is estimated at net revenues of dollar 460 million per year for four years. Recently, they were advised of potential patent infringement and to eliminate this problem they are considering buying a license. SohnCo will sell a license that is good for four years of exclusive use of the patent and associated intellectual property. Alla Aeroshoes uses a corporate MARR of 14 percentage and their risk-free alternatives are 6 percentage. The VP of Engineering at Alla Aeroshoes estimates market volatility in demand is 50 percentage. The VP of Marketing estimates market volatility in demand at 35 percentage. Since the VP's trust you, they asked you to figure out the most they should pay for a license from SohnCo. Alla Aeroshoes is known to be liberal in ignoring intellectual property claims. Imagine they just go ahead with the project as stated above. (In other words, they decide not to pay for the license.) SohnCo aggressively protects their property and sues immediately. Sometime in year 3, (from the start of the effort) a court decision requires Alla Aeroshoes to reimburse SohnCo dollar 500 million. They pay at the end of year 4. How does this strategy work for them? Are they better off licensing or being aggressive?

Explanation / Answer

1. Calculation of maximum amount that can be paid for the license:

Let the maximum amount be X

Therefore, $ 100 + X = $ 400 * PVIFA ( 14%,4)

X = $ 1065.48 million

Hence , the maximum amount that can be paid is $ 1065.48

2. If Alla Aeroshoes pays $500 million to Sohnco,then the NPV of the project is as folllows:

NPV ={ $ 400 * PVIFA (14%,4)} - {$ 100 + $ 500 * PVIF ( 14%,4) }

= $ 769.48

Therefore,ther are better off.

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