You are the CFO of a drug company, and you must decide whether to invest 35M dollars in R&D for a new drug. If you conduct the R&D, you believe that there is a 5% chance that the research will produce a useful drug. If the research is successful, investment in the drug will require an outlay of 500 million dollars. The drug will likely generate annual profits of 130 million for 10 years, until the patent expires. After that, it will generate a cash flow equal to 8 million a year in perpetuity (no growth) . The discount rate is 7%.

a) If the research is successful, what is the net present value of the drug cash flows ?

NPV if successful =

Million Dollars

b) If you invest in R&D, you estimate that it will take 2 years to know whether the drug is successful or not. What is the NPV of the R&D investment?

NPVR&D =

Million Dollars