Bill is the CFO of a drug company, and Bill must decide whether to invest $10M in R&D for a new drug. If Bill conducts the R&D, Bill believes 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. This drug will likely generate annual profits of $75 million for 10 years (starting a year after the $300 million 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%.
Question 1)
If the research is successful, what is the net present value of the drug cash flowsat the time of the $300 million outlay?
NPV if successful = __________million dollars
Question 2)
If Bill invests in R&D, Bill estimates that it will take 2 years to know whether the drug is successful or not. What is the NPV of the R&D investment?
NPV R&D = _____________ million dollars
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