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 $235 million to date working on a cure, but is now at a crossroads. It can either abandon its program or invest another $50 million today. Unfortunately, the firm's opportunity cost of funds is 5 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 Year 2 Year 3 Year 4 $0 $0 $0 $0 Year 5 Year 6 Year 7 Year 8 Year 9 $14,300,000 $16,500,000 $19,200,000 $21,900,000 $24,800,000 What is the net present value of the project? Instruction: Enter your response rounded to the nearest penny (two decimal places). Use a negative sign (-) where appropriate. Should DAS continue with its plan to bring the drug to market, or should it abandon the project? (Click to select) 9

Answer 1

Ans:

Present value = Cash flow / (1+i)^n

where,

i = discount rate

n = period

Net present value is the difference between the present value of series of cash inflow and present value of series of cash outflow over a period of time. If the net present value is positive, the project should be continued.

1)

Net present value of the project = $17,993,700

Calculation of net present value.

Year	Cash Flow	DF@5%	Present value
0	-$50,000,000	1	-$50,000,000
1	$0	0.952	0
2	$0	0.907	0
3	$0	0.864	0
4	$0	0.823	0
5	$14,300,000	0.784	$11,211,200
6	$16,500,000	0.746	$12,309,000
7	$19,200,000	0.711	$13,651,200
8	$21,900,000	0.677	$14,826,300
9	$24,800,000	0.645	$15,996,000
		Net present value	$17,993,700

2) continue

Since the net present value is positive, DAS should continue with its plan to bring the drug to market.