Dr. Harold Wolf of Medical Research Corporation (MRC) was thrilled with the resp

Question

Dr. Harold Wolf of Medical Research Corporation (MRC) was thrilled with the response he 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 is seriously considering two offers. Dr. Wolf’s required rate of return is 8%.

Offer #1: Hampton Drug Co. is offering $1,000,000 now plus $200,000 from end of year 6 through end of year 15. Also, if the product reaches 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 of cumulative sales reaching $100 million (breakdown payments by year 0-15 in formula format)

Offer #2: Zbay Pharmaceutical is offering to pay Dr. Wolf a 35% royalty at the end of the next four years. The royalty is based on Zbay's gross profit margin on expected sales. Sales in year one are projected to be $2,000,000. Sales are expected to grow each year by 40%. Zbay’s gross profit margin is 65%. (Sales in year one are projected to be, Sales are expected to grow each year by, Zbay's gross profit margin is, Dr. Wolf's royalty as percent of gross profit)

Explanation / Answer

Offer #1:

$1000000+ $200000 from year 6 through 15(deffered annuity)

PVA= A*PV(10%, 10Years)

= $200000*6.1

=$1229000 (PV at the begining of the year 6 i.e year 5)

PVA= A*PV(10%, 5Years)

= $1229000 *0.621

=$763209

= +.70*$ 3000000

= $21000000

PVA= A*PV(10%, 15Years)

= $1229000 *.239

= $501900

Total Value of Offer I:

$ 1000000 Payment today

$763209 PV of deffered annuity

$501900 PV of federal 3million bonus

$ 2269109

Offer II:

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