A software company that installs systems for inventory control using RFID technology spent $600,000 per year for the past 3 years in developing their latest product. The company optimistically hopes to recover its investment in 5 years on a single contract beginning immediately (year 0). The company is negotiating a contract that will pay $250,000 now and a to-be-agreed-upon annual increase of a constant amount each year through year 5. How much must the income increase (an arithmetic gradient) each year, if the company wants to realize a return of 15% per year?
What will be an ideal response?
Development cost, year 0 = 600,000(F/A,15%,3)
= 600,000(3.4725)
= $2,083,500
Present worth of contract, year –1 = 250,000(P/A,15%,6) + G(P/G,15%,6)
= 250,000(3.7845) + G(7.9368)
Move development cost to year –1 and set equal to income
2,083,500(P/F,15%,1) = 250,000(3.7845) + G(7.9368)
2,083,500(0.8696) = 250,000(3.7845) + G(7.9368)
G = $109,072
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