Question

example...

say you are a company and thinking about implementing a new laptop for sell, selling an estimate of abokt 10,000 of this new laptop with production of thie new laptop for the next 5 years

you hsve to pay a royalty fee to apple for using one of their services for this new laptop

you have 2 investment options for this royalty fee

1. fixed one time fee of $200,000 which covers thr 5 years of production plus future years if production is extended

2. fee of $30 per unit which impacts future years production

how would you go about choosing an option?

if numbees are missing like selloing price or other variable costs just make them up. i am trying yo undertand this concept thank you

Answer 1

Method 1 of evaluation

Allocate time value of money to the payments, draw up business cash flows

Eg if option 2 is selected and 2000 units are sold each year, assuming cost of capital to be 10%. Then Present value of such payment shall be= 2000X30 X 3.79(PVAnnuity Factor for 5 years) = 227400 which can be compared with one time payment of 200000. Also insert these figues in business cashflow to analyse tax implications and whether payment obligations can be met based on projected inflows

Method 2 of evaluation

To evaluate option 1: Fixed cost of 200,000 / (SP per unit -VC per unit) this will give break even number of units to be sold to recover $200,000 can be compared with projected sales. If the break even units are more than projected sales it might be advisable to go for per unit royalty