A project with an up-front cost at t=0 of $1500 is being considered by Nationwide Pharmaceutical Corporation (NPC). (All dollars in this problem are in thousands.) The projects subsequent cash flows are critically dependent on whether a competitors product is approved by the Food and Drug Administration. If the FDA rejects the competitive product, NPCs product will have high sales and cash flows, but if the competitive product is approved, that will negatively impact NPC. There is a 75% chance that the competitive product will be rejected, in which case NPCs expected cash flows will be $500 at the end of each of the next seven years (t = 1 to 7). There is a 25% chance that the competitors product will be approved, in which case the expected cash flows will be only $25 at the end of each of the next seven years (t = 1 to 7). NPC will know for sure one year from today whether the competitors product has been approved.

CF if invest today

Scenario	Probability	T=0	T =1 to 7
Competitive product is APPROVED by FDA	0.25	-$1,500	$25
Competitive product is REJECTED BY FDA	0.75	-$1,500	$500

NPC is considering whether to make the investment today or to wait a year to find out about the FDAs decision. If it waits a year, the projects up-front cost at t = 1 will remain at $1,500, the subsequent cash flows will remain at $500 per year if the competitors product is rejected and $25 per year if the alternative product is approved. However, if NPC decides to wait, the subsequent cash flows will be received only for six years (t = 2 ... 7).

CF if wait a year

Scenario	Probability	T=1	T =2 to 7
Competitive product is APPROVED by FDA	0.25	-$1,500	$25
Competitive product is REJECTED BY FDA	0.75	-$1,500	$500

Assuming that all cash flows are discounted at 10%, and the cost of project is discounted at the risk-free rate of 3% if NPC waits for 1 year.

What is projects NPV if competitors products are approved by the FDA? And what is projects NPV if competitors products are rejected by the FDA?

Approved = $1,378.28, Rejected = -$1,378.28

Approved = $934.20, Rejected = -$787.91

Approved = -$1,378.29, Rejected = $934.20

Approved = -$1,258.90, Rejected = -$934.20

Approved = $787.91, Rejected = -$1,328.28

What is the projects expected NPV if NPC undertakes the investment today?

$356.08

-$356.08

$700.657

-$344.57

$934.21

If NPC waits for 1 year, what is projects NPV if competitors products are approved by FDA

$356.08

-$1,357.32

$700.657

-$1,378.28

$523.35

What is the projects expected NPV if NPC waits for 1 year?

$32.81

$45.89

$335.67

$67.91

$53.18

What is the projects standard deviation if NPC waits for 1 year?

$814.35

$1,001.34

$45.89

$67.91

$32.81

What is the Coefficient variation of the project (C.V.) if NPC waits for 1 year?

$45.89

$81.76

$15.31

$10.89

$32.81

Should NPC proceed today or wait a year? Why?

	Wait 1 year because NPV of waiting > NPV of proceeding today.
	Wait 1 year because NPV of waiting < NPV of proceeding today.
	Proceed today because NPV of Proceeding today > NPV of waiting.
	Proceed today because NPV of Proceeding today < NPV of waiting.
	Wait 1 year because it reduces the risk of the project.