Dr. Harold Wolf of Medical Research Corporation (MRC) was thrilled with the response he received from drug companies for his latest discovery, a unique electronic stimulator that reduces the pain from arthritis. 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 is seriously considering two offers. Dr. Wolfs required rate of return is 8%.

Offer #1: Hampton Drug Co. is offering $1,000,000 now plus $200,000 from end of year 6 through end of year 15. Also, if the product reaches 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 of cumulative sales reaching $100 million.

Offer #2: Zbay Pharmaceutical is offering to pay Dr. Wolf a 35% royalty at the end of the next four years. The royalty is based on Zbay's gross profit margin on expected sales.

Sales in year one are projected to be $2,000,000. Sales are expected to grow each year by 40%. Zbays gross profit margin is 65%.

Dr. Harold Wolf of Medical Research Corporation (MRC) was thrilled with the response he received from drug companies for his latest discovery, a unique electronic stimulator that reduces the pain from arthritis. 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 is seriously considering two offers (described on the following tabs). Your assignment is to establish the present value of each of the offers and then send an email to Dr. Wolf recommending an offer. You will need to explain to Dr. Wolf why you are dismissing the other offer. (Hint: "Because it is smaller or less" is not sufficient reason.)

Dr. Wolf's Required Return

8%

Present Value of Offer #1

Present Value of Offer #2

Hampton Drug Co. is offering $1,000,000 now plus $200,000 from end of year 6 through end of year 15. Also if the product reaches 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 of cumulative sales reaching $100 million.

Year 0

Year 1

Year 2

Year 3

Year 4

Year 5

Year 6

Year 7

Year 8

Year 9

Year 10

Year 11

Year 12

Year 13

Year 14

Year 15

Bonus if cumulative sales reach $100 million by end of year 15

$3,000,000

Payments by year

Probability of cumulative sales reaching $100 million by end of year 15

70%

Determine the present value of Offer #1.

In this offer, Zbay Pharmaceutical is offering to pay Dr. Wolf a 35% royalty at the end of the next four years. The royalty is based on Zbay's gross profit margin on expected sales.
Sales in year one are projected to be
Sales are expected to grow each year by
Zbay's gross profit margin is
Dr. Wolf's royalty as percent of gross profit
Year	Projected Sales	Zbay Gross Profit	Dr. Wolf's Payment
1
2
3
4
Determine the present value of Offer #2.