Q7
You are the CFO of a drug company, and you must decide whether to invest 10M dollars in R&D for a new drug. If you conduct the R&D, you believe that there is a 5% chance that the research will produce a useful drug. If the research is successful, investment in the drug will require an outlay of 300 million dollars. The drug will likely generate annual profits of 75 million for 10 years (starting a year after the 300 million dollar outlay), until the patent expires. After that, it will generate a cash flow equal to 5 million a year in perpetuity (no growth) . The discount rate is 8%.
a) If the research is successful, what is the net present value of the drug cash flows at the time of the 300 dollar million outlay?
NPV if successful = $ Million Dollars
b) If you invest in R&D, you estimate that it will take 2 years to know whether the drug is successful or not. What is the NPV of the R&D investment?
NPVR&D = $ Million Dollars
