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Demand High p = 0.25 $55M 3- (15 points) Consider the research-and-development decision below. License Patent Technology Awarded $25M Continue p = 0.7 Development -

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Demand High p = 0.25 $55M 3- (15 points) Consider the research-and-development decision below. License Patent Technology Awarded $25M Continue p = 0.7 Development - $2M Develop Production and Marketing to Sell Product Directly -$10M No Patent -$2M p = 0.3 Demand Medium p=0.55 $33M Demand Low p = 0.20 $15M Stop Development $0 If you decide to continue the project, you will have to come up with the $2 million this year (Year 1). Then there will be a year of waiting (Year 2) before you know if the patent is granted. If you decide to license the technology, you would receive the $25 million distributed as $5 million per year beginning in Year 3. On the other hand, if you decide to sell the product directly, you will have to invest $5 million in each of Years 3 and 4 (to make up the total investment of $10 million). Your net proceeds from selling the product, then, would be evenly distributed over Years 5 through 9. Cash flows of the each alternative plan is presented below. Assuming an interest rate of 15%, calculate the NPV at the end of each branch of the decision tree. Which will be the best decision in terms of NPV? Stop Cash Flows Continue Continue No Patent Patent License 0 -2 Year 0 1 2 3 4 5 6 7 8 OOOOOOOO Continue Continue Continue Patent Patent Patent Develop Develop Develop Dem. High Dem. Med Dem. Low 0 0 0 -2 -2 -2 0 0 0 -5 -5 -5 -5 -5 -5 11 6.6 3 11 6.6 3 11 6.6 3 11 6.6 3 11 6.6 5 5 5 5 5 00 a Demand High p = 0.25 $55M 3- (15 points) Consider the research-and-development decision below. License Patent Technology Awarded $25M Continue p = 0.7 Development - $2M Develop Production and Marketing to Sell Product Directly -$10M No Patent -$2M p = 0.3 Demand Medium p=0.55 $33M Demand Low p = 0.20 $15M Stop Development $0 If you decide to continue the project, you will have to come up with the $2 million this year (Year 1). Then there will be a year of waiting (Year 2) before you know if the patent is granted. If you decide to license the technology, you would receive the $25 million distributed as $5 million per year beginning in Year 3. On the other hand, if you decide to sell the product directly, you will have to invest $5 million in each of Years 3 and 4 (to make up the total investment of $10 million). Your net proceeds from selling the product, then, would be evenly distributed over Years 5 through 9. Cash flows of the each alternative plan is presented below. Assuming an interest rate of 15%, calculate the NPV at the end of each branch of the decision tree. Which will be the best decision in terms of NPV? Stop Cash Flows Continue Continue No Patent Patent License 0 -2 Year 0 1 2 3 4 5 6 7 8 OOOOOOOO Continue Continue Continue Patent Patent Patent Develop Develop Develop Dem. High Dem. Med Dem. Low 0 0 0 -2 -2 -2 0 0 0 -5 -5 -5 -5 -5 -5 11 6.6 3 11 6.6 3 11 6.6 3 11 6.6 3 11 6.6 5 5 5 5 5 00 a

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