Mr. Landis, President of the Modern Weapons, Inc. was pleased to hear that he had three offers from major defence companies for his newest missile firing automatic ejector. He will use a discount rate of 12 percent to appraise each offer.
Offer1: $500,000 now plus $120,000 from the ending of years 6 thru 15. Also, if the product goes over $50 million in cumulative sales by the end of year 15, he will collect an additional $1,500,000. Mr Landis thought there was a 75 percent chance this would happen.
Offer2: Twenty-five percent of the buyers gross margin for the subsequently four years. The buyer in this case is Air Defences, Inc. (ADI). Its gross margin is 65 percent. Sales for year 1 are projected to be $1 million and then grow by the 40 percent per year. This amount is paid today and is not discounted.
Offer3: A trust fund would be set up for the subsequently nine years. At the ending of that period, Mr. Landis would get the proceeds (and discount them back to the percent 12 percent). The trust fund called for half yearly payments for the subsequently nine years of $80,000 (a total of $160,000 per year). The payments would start instantly. Since the payments are coming at the starting of each period instead of the end, this is an annuity due. Suppose the yearly interest rate on this annuity is 12 percent yearly (6 percent half yearly). Find out the present value of the trust's funds value.
Find out the present value of each of three offers and then indicate which one has the uppermost present value.