Question

Approximately 14 million Americans are addicted to drugs and alcohol. The federal government estimates that these addicts cost the U.S. economy $300 billion in medical expenses and lost productivity. Despite the enormous potential market, many biotech companies have shied away from funding research and development (R&D) initiatives to find a cure for drug and alcohol addiction. Your firm – Drug Abuse Sciences (DAS) – is a notable exception. It has spent $240 million to date working on a cure, but is now at a crossroads. It can either abandon its program or invest another $55 million today. Unfortunately, the firm’s opportunity cost of funds is 8 percent and it will take another five years before final approval from the Federal Drug Administration is achieved and the product is actually sold. Expected (year-end) profits from selling the drug are presented in the accompanying table.

Year 1 $0

Year 2 $0

Year 3 $0

Year 4 $0

Year 5 $12,500,000

Year 6 $14,000,000

Year 7 $15,700,000

Year 8 $18,300,000

Year 9 $20,400,000

What is the net present value of the project?

Enter your response rounded to the nearest penny (two decimal places). Use a negative sign (-) where appropriate.

Answer 1

The amount of 240 million what he spent alreay is not relevent now. Since it can be considered as a sunk cost, will not be taken into account.

We will consider the investment of 55 million today as in initial investment.

The rate of interest will be 8%

The estimated end of year profits will be

Year 1           $0

Year 2           $0

Year 3           $0

Year 4           $0

Year 5           $12,500,000

Year 6           $14,000,000

Year 7           $15,700,000

Year 8           $18,300,000

Year 9           $20,400,000

Net Present Value of the investment will be

NPV = -55,000,000 + 12,500,000 (1 + 0.08) ^{– 5} + $14,000,000 (1 + 0.08) ^{– 6} + $15,700,000 (1 + 0.08) ^{– 7} + $18,300,000 (1 + 0.08) ^{– 8} + $20,400,000 (1 + 0.08) ^{– 9}

NPV = -8,417,536.53

As the NPV is negative, the company should not invest the money.