Premier Pharmaceutical is a well-established pharmaceutical company with a number of patented drugs under its belt. However two of their main patents have recently expired and, despite having a number of projects in the pipeline, their stock price performance had tumbled in the past year or so due to a relatively weak performance of a couple of its drugs.

One of the main problems facing the pharmaceutical industry was the difficulty in making accurate risk/return predictions mainly because companies had to obtain the approval from the Food and Drug Administration (FDA) before being able to market the new drugs.

The Vision Research division of the company had recently developed a new drug, ClearView, for the cure of myopia which seem to be very promising based on some preliminary tests. The company had asked James Thorne, their product development manager to assess whether it made sense to go ahead with the project. James had therefore carefully analysed the cost and revenue estimates for the project in order to calculate its Net Present Value.

Specifically James had estimated that developing the new drug would cost $80 million in development cost and $10 million in testing cost now. As additional $80 million in marketing cost will be spent at the end of the year upon receiving FDA approval. Production and sales could then start and the first cash flow would accrue in two years. In order to assess the cash flow generated by the sale of the new drug, James has estimated that the population with myopia, currently amounting to 40 million people, would grow at annual growth rate of 3% in future years and that the company should be able to secure 8% of the existing market for drugs against myopia. He also assumed that the market for drugs against myopia will be profitable for another 10 years after which itll dried up, hence it was crucial to act fast to seize the opportunity. Finally, he had calculated that the Net Cash Flow per customer would be $10 and this would remain constant throughout the life of the project.

1a) Using the information provided calculate the NPV of producing and selling the new drug. Note that James assumes that the company will be granted the FDA approval within a year.

When James presented his results at the board of directors, one of the directors raised the question :Have you considered the possibility that we may not get the FDA approval within one year, if at all? What do we do then?. James suggests to re-run the NPV analysis to account for the risk of a delay or possibly a rejection of the FDA approval. To this purpose he estimates that, based on the existing evidence, the probability of a rejection is fairly small while, on the contrary, the delays in getting approval have become more and more frequent in recent years. He estimates that there is a 50% chance that the FDA approval is delayed by 2 years..

1b) . Calculate how the NPV of the project would change after taking into consideration the contingency that the drug might not be sold until year 3 because of a delay in getting FDA approval?