Medical Research Corporation (Comprehensive time valueof money) Dr. Harold Wolf of Medical Research Corporation(MRC) was thrilled with the response he had received from drugcompanies for his latest discovery, a unique electronic stimulatorthat reduces the pain from arthritis. The process had yet to passrigorous Federal Drug Administration (FDA) testing and was still inthe early stages of development, but the interest was intense. Hereceived the three offers described following this paragraph.(A 10 percent interest rate should be used throughoutthis analysis unless otherwise specified.)
Offer I - $1,000,000 now plus $200,000from year 6 through 15. Also, if the product did over $100 millionin cumulative sales by the end of year 15, he would receive anadditional $3,000,000. Dr. Wolf thought there was a 70 percentprobability this would happen.
Offer II - Thirty percent of thebuyer’s gross profit on the product for the next four years. Thebuyer in this case was Zbay Pharmaceutical. Zbay’s gross profitmargin was 60 percent. Sales in year one were projected to be $2million and then expected to grow by 40 percent per year.
Offer III - A trust fund would be setup for the next eight years. At the end of that period, Dr. Wolfwould receive the proceeds (and discount them back to the presentat 10 percent). The trust fund called for semiannual payments forthe next eight years of $200,000 (a total of $400,000 peryear).
The payments would start immediately. Since the payments arecoming at the beginning of each period instead of the end, this isan annuity due. To look up the future value of an annuity due inthe tables, add 1 to n (16 + 1) and subtract 1 from thevalue in the table. Assume the annual interest rate on this annuityis 10 percent annually (5 percent semiannually).Determine the present value of the trust fund’s final value.
Required: Find the present value of each of the threeoffers and indicate which one has the highest presentvalue.
