Loral Drugs is a biotechnology firm that is working on a new drug to treat insomnia. The drug is working its way through the FDA approval process and is expected to generate $150 million in after-tax cash flows each year for 15 years, once it is approved. There are two more hurdles that the drug has to cross before approval:

A small sample test on laboratory animals that will take a year to complete and is expected to cost $100 million (to be spent today); there is an 80 percent chance that it will succeed.

If the lab animal test succeeds, it will be followed by a study on human subjects that will take two additional years to complete and cost $250 million (to be spent at the end of year 1); there is a 60 percent chance that this study will yield favorable results.

The cost of capital for biotechnology firms is 10%.

a. Outline the decision tree for the insomnia drug.

b. Estimate the expected value of the drug to the company today.