Mr. Landis, President of Modern Weapons, Inc. was pleased that he had three offers from major companies for his latest missile firing automatic ejector. He can use a discount rate of 12 percent to compute each offer.
Offer1 :
$500,000 now plus $120,000 from the end of years 6 thru 15. And also, if the product goes over $50 million in cumulative sales by the end of year 15, he can receive an additional $1,500,000. Mr Landis thought there was a 75 percent chance this would happen.
Offer2 :
25 percent of the buyers gross margin for the next four years. The buyer in this case is Air Defense, Inc. (ADI). It's gross margin is 65 percent. Sales for year 1 are projected to be $1 million and then grow by 40 percent per year. This amount is paid today and is not discounted.
Offer3 :
A trust fund could be set up for the next nine years. At the end of that period, Mr. Landis could receive the proceeds (and discount them back to the percent 12 percent). The trust fund known as for semiannual payments for the next nine years of $80,000 (a total of $160,000 per year). The payments could start immediately. Since the payments are coming at the starting of each period instead of the end, this is an annuity due. To look up the future value in the table. Consider the annual interest rate on this annuity is 12 percent annually (6 percent semiannually). Evaluate the present value of the trust's funds value.
Determine the present value of each of the three offers and then show which one has the highest present value.