Amber is the owner of a coupon that permits the bearer to receive a government rebate of $10 million upon the construction and operation of a specialized piece of machinery. The coupon is redeemable by any holder meeting the requirements (possess the capital and necessary permits to construct the equipment), immediately, but has a clawback feature, that if in 2 years the piece of eqipment is not operating at expected levels, $5 million of the rebate would have to be paid back to the government.
Amber doesn’t have the permits or the capital to build such a piece of equipment, but there are 3 other individuals, Bobby, Charlie, and Don, that have the capital, have obtained the permits and have the intention of building the equipment, but none of them posess a coupon that Amber does.
A has approached each B, C, and D with the offer to sell one of them the coupon. To A alone, the coupon is worthless, but to B, C, or D the coupon is worth between $5 and $10 million.
If you are Bobby how much would you be willing to pay Amber for the coupon? And why would that be a fair price to Amber? Why would that be a fair price for Bobby?
Bobby simply needs to figure out what his profit margin would be if he already had the coupon and then decide how much less of a margin he can live with. The balance is the maximum he should pay for the coupon.
Amber should ask whatever the market will bear which would best be decided by auction since there are at least three likely buyers.
Bobby’s cash flow will increase by $10MM if he is able to have the equipment operating at spec, but only $5MM if it isn’t.
Amber’s market consist of 3 people, all who have similar economics to Bobby.
If Bobby pays her $10MM, the best case is he breaks even, worst case he loses $5MM. This doesn’t seem fair to Bobby.
If Bobby pays her $5MM, then the best case is Bobby is up $5MM and worst case is he breaks even. This also doesn’t seem fair to Bobby as he’s taking all of the risk with limited upside, whereas Amber get’s $5MM regardless.
If Bobby pays her $2.5MM, then Bobby’s best case is he’s up $7.5MM and the worst case is he’s up $2.5MM. This seems fair to Bobby, as they share 50/50 in the worst case outcome. And Amber is $2.5 MM up regardless.
Bobby, Charlie and Don may have different estimates of their likelihoods to have the equipment operating at expected levels, leading them to value the coupon differently. If Bobby thinks there’s only a 1/3 chance he’ll have it working correctly, and Don is sure he can, I’d expect Don to be willing to pay more than Bobby.