What is the maximum consideration a buyer should offer if a seller has a 40% chance of winning a $100 million patent infringement lawsuit, assuming a 12% cost of capital?

To determine the maximum consideration a buyer should offer when assessing the value of a potential patent infringement lawsuit, one needs to consider the probability of success and the potential financial outcome from that success.

In this scenario, the seller has a 40% chance of winning a $100 million lawsuit. To find the expected value of the lawsuit, you multiply the probability of winning by the potential payout:

Expected Value = Probability of Winning × Potential Payout

= 0.40 × $100 million

= $40 million.

However, due to the cost of capital, which represents the buyer's minimum required return on an investment, this expected value must be discounted to reflect its present value. Given a 12% cost of capital, we need to account for the time value of money in our calculation.

The present value of the expected payout (assuming it would be realized in the future rather than instantly) can be calculated using the formula for present value:

Present Value = Expected Value / (1 + rate of return)

= $40 million / (1 + 0.12)

= $40 million / 1.12

= approximately $35.71 million.

The correct maximum offer for the buyer should not normally exceed this present value