A project with an up-front cost at t = 0 of $1500 is being considered by...

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A project with an up-front cost at t = 0 of $1500 is beingconsidered by Nationwide Pharmaceutical Corporation (NPC). (Alldollars in this problem are in thousands.) The project's subsequentcash flows are critically dependent on whether a competitor'sproduct is approved by the Food and Drug Administration. If the FDArejects the competitive product, NPC's product will have high salesand cash flows, but if the competitive product is approved, thatwill negatively impact NPC. There is a 75% chance that thecompetitive product will be rejected, in which case NPC's expectedcash flows will be $500 at the end of each of the next seven years(t = 1 to 7). There is a 25% chance that the competitor's productwill be approved, in which case the expected cash flows will beonly $25 at the end of each of the next seven years (t = 1 to 7).NPC will know for sure one year from today whether the competitor'sproduct has been approved.
NPC will proceed with the investment today to take advantage ofthe untapped market potential and at the end of the projects life,after finding out about the FDA,s decision about the demand forcompetitors product, they will decide wether or not to renew thepatent and return the project. The project return's up-front cost(at t=7) will remain at $1,500, and the subsequent cash flows willremain unchanged and will be recieved for seven additional years(t=8...14). They will only return the project if the return of theproject adds value.
Assuming that all cash flows are discounted at 10%, what is theNPV of the project with and without growth option?

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3.6 Ratings (287 Votes)

NPV without Growth Option Good Scenario 75 Worse Scenario 25 Year PV Factors Cash Flows PV Cash Flows PV 0 1 1500 1500 1500 1500 1 09090909 500 45455 25 2273 2 08264463 500 41322 25 2066 3 07513148 See Answer

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A project with an up-front cost at t = 0 of $1500 is beingconsidered by Nationwide Pharmaceutical Corporation (NPC). (Alldollars in this problem are in thousands.) The project's subsequentcash flows are critically dependent on whether a competitor'sproduct is approved by the Food and Drug Administration. If the FDArejects the competitive product, NPC's product will have high salesand cash flows, but if the competitive product is approved, thatwill negatively impact NPC. There is a 75% chance that thecompetitive product will be rejected, in which case NPC's expectedcash flows will be $500 at the end of each of the next seven years(t = 1 to 7). There is a 25% chance that the competitor's productwill be approved, in which case the expected cash flows will beonly $25 at the end of each of the next seven years (t = 1 to 7).NPC will know for sure one year from today whether the competitor'sproduct has been approved.NPC will proceed with the investment today to take advantage ofthe untapped market potential and at the end of the projects life,after finding out about the FDA,s decision about the demand forcompetitors product, they will decide wether or not to renew thepatent and return the project. The project return's up-front cost(at t=7) will remain at $1,500, and the subsequent cash flows willremain unchanged and will be recieved for seven additional years(t=8...14). They will only return the project if the return of theproject adds value. Assuming that all cash flows are discounted at 10%, what is theNPV of the project with and without growth option?