1: HerbTech Inc., invests aggressively in basic R&D 1 ; this research tends to behit or miss! The company is hoping to successfully launch a new product one year from today this is a product that was created from this basic R&D. The company is currently in the beta-testing 2 phase of this product; this requires an investment today of $15M. In one year, the testing will be complete AND if successful the product will be launched; the go-to-market strategy will cost $150M in one year. In the subsequent year, year 2, after- tax free-cash flow from this product is estimated as $40M. This is expected to grow at a rate of 8% each year for four years. 3 The product will end its useful life five years after launch. The new product has a similar level of risk as the companys existing business. Therefore, HerbTechs cost of capital of 12% is appropriate for the new product.

a) Using DCF and NPV analysis and, ignoring the Real Option analysis that you will prepare in part b), is it worth investing the initial $15M in this project. (assume this project is successfully launched)

(b) The returns from the new product are expected to have an annual standard deviation of 40%. If the risk-free rate is 3.0%, is it worth spending $15M today to begin the beta-testing?