\"A corporation is trying to decide whether to buy the patent for a product desi
ID: 2530103 • Letter: #
Question
"A corporation is trying to decide whether to buy the patent for a product designed by another company. The decision to buy will mean an investment of $9.9 million, and the demand for the product is not known. If demand is light, the company expects a return of $2.35 million each year for the first three years and no return in the fourth year. If demand is moderate, the return will be $3.73 million each year for four years, and high demand means a return of $4.55 million each year for four years. It is estimated the probability of a high demand is 0.51, and the probability of a light demand is 0.17. The firm's interest rate is 15.7%.
Calculate the expected present worth of the patent. Express your answer in millions of dollars. For example, if the answer is $12.3 million, enter 12.3. (All figures represent after-tax values.)"
Explanation / Answer
Answer is $10.79 million.
Inflows as per question
Inflows multiplied with Probability
Demand
Probability
Yr 1
Yr 2
Yr 3
Yr 4
Yr 1
Yr 2
Yr 3
Yr 4
Light
17%
2.35
2.35
2.35
0.40
0.40
0.40
0.00
Moderate
32%
3.73
3.73
3.73
3.73
1.19
1.19
1.19
1.19
High
51%
4.55
4.55
4.55
4.55
2.32
2.32
2.32
2.32
Total
3.91
3.91
3.91
3.51
Demand in Millions for year 1 to year 4 will be calculated as above
Present value factor
0.8643
0.7470
0.6457
0.5580
Let’s multiply PVF with the inflows we computed above
Yr 1
Yr 2
Yr 3
Yr 4
3.3825
2.9235
2.5268
1.9610
Present Worth for patent is equal to present value for future cash flows. If we total the present values for Year 1 to Year 4, we reach at the total present value for $10.79 million.
Inflows as per question
Inflows multiplied with Probability
Demand
Probability
Yr 1
Yr 2
Yr 3
Yr 4
Yr 1
Yr 2
Yr 3
Yr 4
Light
17%
2.35
2.35
2.35
0.40
0.40
0.40
0.00
Moderate
32%
3.73
3.73
3.73
3.73
1.19
1.19
1.19
1.19
High
51%
4.55
4.55
4.55
4.55
2.32
2.32
2.32
2.32
Total
3.91
3.91
3.91
3.51
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