Part B: Advanced techniques in Investment decision $-$ Real Option Analysis

Chemis Pharmaceutical Incorporation $($CPI$)$ is a medium$-$sized pharmaceutical supplier for Australasian region. CPI has just attained a $15-$year exclusive right to launch a new nasal spray which helps with clogged nose faster than any other ones available in the over$-$the$-$counter market $($assumed no rivals or substitutions for a foreseeable future$)$ called $$Ouvertin$.$ With the co$-$operations of the marketing$/$production$/$financial teams of CPI, the estimated average cash flows for launching $$Ouvertin$$ emerge as follows:

Half$-$year Cash flows

$0-10000000$

$1200000$

$2300000$

$3360000$

$4400000$

$5600000$

$6800000$

$71000000$

$81000000$

$91200000$

$101200000$

$111400000$

$121600000$

$131600000$

$141200000$

$151000000$

$161000000$

$171000000$

$181000000$

$191000000$

$201000000$

$211000000$

$22800000$

$23800000$

$24600000$

$25600000$

$26600000$

$27400000$

$28400000$

$29400000$

$30400000$

The product is within the same line of CPI existing business while its cost of capital is $11\mathrm{.}5\%$ per year. In addition, launching Ouvertin will not alter the company$$s cost of capital. The launching of Ouvertin will cost $$10$ million at any point in time during the next fifteen years and is fixed $($at $$10$ million$).$ The $15-$year government bond YTM is observed as $3\mathrm{.}5\%$ per year in the government bond market. The pharmaceutical product market is quite volatile in its nature. The six$-$month stock return variance on this industry$$s stock portfolio in the relevant markets is estimated as $21\%.$ For simplicity, let$$s assume that the rate of decay on the product launching project is constant through time.

Questions:

$1.$ Should CPI should go ahead with the launching of the new product $-$ Ouvertin?

Provide a numerical justification in the context of $$real option analysis$.$ The use of

Black and Scholes model in Excel $($submitted separately$)$ to justify your numbers is

also required

Note:

$-$ Assume e $=2\mathrm{.}718$ as we always do in class and lecture note.