Sub: Finance Topic: Capital Budgeting
Question:
Dr. Harold Wolf of 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.
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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 received the three offers
described below this paragraph. (A 10 percent interest rate should be used throughout this
analysis unless otherwise specified.)
Offer I $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.
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Sub: Finance Topic: Capital Budgeting
Solution:
Offer I
Additional Cash
with a probability
of 70% at the end Total Cash Flow Present Values
Year Cash Flows of 15th year = = (PV) =
1 $1,000,000 $1,000,000 1000000
2 $1,000,000 $1,000,000 1000000
3 $1,000,000 $1,000,000 1000000
4 $1,000,000 $1,000,000 1000000
5 $1,000,000 $1,000,000 1000000
6 $1,000,000 $1,000,000 1000000
7 $1,200,000 $1,200,000 1200000
8 $1,200,000 $1,200,000 1200000
9 $1,200,000 $1,200,000 1200000
10 $1,200,000 $1,200,000 1200000
11 $1,200,000 $1,200,000 1200000
12 $1,200,000 $1,200,000 1200000
13 $1,200,000 $1,200,000 1200000
14 $1,200,000 $1,200,000 1200000
15 $1,200,000 3000000 $4,200,000 1005446.61
Total Present Value of the Offer I = $16,605,446.61
** End of the Solution **
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Finance, Marketing, Statistics, Economics and others. Check out more solved problems in our Solution Library.
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*The Homework solutions from ClassOf1 are intended to help the student understand the approach to solving the problem and not for submitting
the same in lieu of your academic submissions for grades.