New Dawn Pharma is considering the acquisition of a small biotech company - Sunset Pharmaceuticals. Sunset is developing a new drug that, if successful, would revolutionize the treatment of pancreatic and/or liver cancer. Sunset is about to start Phase 1 of the clinical testing for the new drug. New Dawn estimates that if they acquired Sunset, the costs associated with Phase 1 testing would be around $60 million. They believe the probability of successful Phase 1 testing is 30%.

Phase 2 testing for the pancreatic cancer and/or liver cancer indication would cost $170 million. The probability that Phase 2 testing will show effectiveness for pancreatic cancer is 25%. The Probability that Phase II shows clinical efficacy for liver cancer is only 45%.

Phase 3 testing for the liver cancer indication only will cost $300 million. The probability that Phase 3 testing for pancreatic cancer will be successful is 40% and the cost of launching the drug for the pancreatic indication only will be $250 million. New Dawn estimates that future cash flows from a successful pancreatic cancer indication will be in the vicinity of $10 billion.

Phase 3 testing for the liver cancer indication only will cost $350 million. The probability that Phase 3 testing will show effectiveness for liver cancer is 70% and the cost of launching the drug for the liver indication only will be $200 million. Estimates for future cash flows from a successful liver cancer launch are in the vicinity of $20 billion.

(All cash flows are expressed after-tax present values discounted to time zero, including capital expenditure)

a. What is the NPV of Sunset's new drug line? Based on this estimate, should New Dawn pursue the acquisition? Show all your work.

b. Sunset has about $70 million in fixed assets and $500 million in debt/outstanding obligations to investors that will have to be paid off before the merger can proceed. Sunset is being sued by an academic partner for patent infringement on their new drug line. If the lawsuit is settled, they will have to pay around $200 million to the University. New Dawn's lawyers are saying that this is likely to happen with probability 95%. However, if the University is not willing to settle and they go to court, there is a 30% probability that the University will receive 30% of any and all proceeds from the drug's sales and will not share any of the costs of development. Based on this information, what is the value of Sunset as a stand-alone company?

c. New Dawn estimates that the value created from acquisition will be in the order of $600 million. They also think that the deal will need about $0.8 million in work. How much should the New Deal be willing to pay in consideration?