Reference no: EM132498369

Comprehensive time value of money

Dr. Harold Wolf of the Medical Research Corporation (MRC) was thrilled with the response he had received from drug companies for his latest discovery, a unique electronic stimulator that reduces the pain from arthritis. This process had yet to pass rigorous Federal Drug Administration (FDA) testing and was still in early stages of development, but the interest was intense. He received the three offers described in the following paragraph. (A 10 percent interest rate should be used throughout this analysis unless otherwise specified.)

Offer 1: $1,000,000 now plus $200,000 from year 6 through 15. Also if the product did 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 this would happen.

Offer 2: Thirty percent of the buyer's gross profit on the product for the next 4 years. The buyer in this case was Zbay Pharmaceutical. Zbay's gross profit margin was 60 percent. Sales in year one were projected to be $2 million and then expected to grow by 40 percent per year.

Offer 3: A trust fund would be set up for the next 8 years. At the end of that period, Dr. Wolf would receive the proceeds (and discount them back to the present at 10 percent). The trust fund called for semiannual payments for the next 8 years of $200,000 (a total of $400,000 per year).

Question 1: The payments would start immediately. Since the payments are coming at the beginning of each period instead of the end, this is an annuity due. Assume the annual interest rate on this annuity is 10 percent annually (5 percent semiannually). Determine the present value of the trust fund's final value. Hint: See the section on Annuities