Alla Aeroshoes is in the business of designing and manufacturing running shoes f
ID: 2740294 • Letter: A
Question
Alla Aeroshoes is in the business of designing and manufacturing running shoes for long distance runners. They are considering a $100 million upgrade to their production line for the iPhone/iPad/iWatch connected shoe that has Bluetooth connectivity. The potential cash flow is estimated at net revenues of $460 million per year for four years. Recently, they were advised of potential patent infringement and to eliminate this problem they are considering buying a license. SohnCo will sell a license that is good for four years of exclusive use of the patent and associated intellectual property. Alla Aeroshoes uses a corporate MARR of 14% and their risk-free alternatives are 6%. The VP of Engineering at Alla Aeroshoes estimates market volatility in demand is 50%. The VP of Marketing estimates market volatility in demand at 35%.
1. Since the VP’s trust you, they asked you to figure out the most they should pay for a license from SohnCo.
2. Alla Aeroshoes is known to be liberal in ignoring intellectual property claims. Imagine they just go ahead with the project as stated above. (In other words, they decide not to pay for the license.) SohnCo aggressively protects their property and sues immediately. Sometime in year 3, (from the start of the effort) a court decision requires Alla Aeroshoes to reimburse SohnCo $500 million. They pay at the end of year 4. How does this strategy work for them? Are they better off licensing or being aggressive
Explanation / Answer
Alla Aeroshoes new product launch with alternatives of paying for patent or without
Description Cash flows Based on Demand Cash flows PV factor 15% PV cash flows
50% 35% 50% 35%
Investment -100 -100 -100 1 -100 -100
1st Year 460 230 161 0.877 202 141
2nd Year 460 230 161 0.769 177 124
3rd Year 460 230 161 0.675 155 109
4th Year 460 230 161 0.592 136 95
4th Year (Patent) -500 0.592 -296 -296
Total 1240 420 144 274 73
Notes:
1.VP engineer estimates the demand is 50% and VP market estimates demand 35%, in both the cases the cash flows for the firm is beneficial
2. Alla aerroshoes can proceed without paying the patent protection payment to Shan & Co in the inital year and based on the court order pay at the end of 4th year could earn a return of income more than the interest free rate of return even at demand of 35%
3. It is better off being aggressive
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