Question

You are offered a three year distribution contract for a technology product with a short market life. Your initial costs for the rights to sell the product are $2,500,000. Your first year net cash flow is estimated to be $3,400,000, after which it will decrease each year by 50% of the previous year’s net cash flow. You may assume that your interest rate for available investments is 9%. Will you sign the distribution contract or just invest in the investment pool?

Answer 1

i = 9%

investment = 2500000

Cash flow in year 1 = 3400000

CAsh flwo in yr 2 = 50% * 3400000 = 1700000

Cash flow in yr 3 = 50% * 1700000 = 850000

NPW = -2500000 + 3400000/(1+0.09) + 1700000/(1+0.09)^2 + 850000/(1+0.09)^3

= -2500000 + 3400000/(1.09) + 1700000/(1.09)^2 + 850000/(1.09)^3

= 2706478

As NPW is positive, we should selected the distribution project