Question

Approximately 14 million Americans are addicted to drugs and alcohol. The federal government estimates that these addicts cost the U.S. economy $300 billion in medical expenses and lost productivity. Despite the enormous potential market, many biotech companies have shied away from funding research and development (R&D) initiatives to find a cure for drug and alcohol addiction. Your firm – Drug Abuse Sciences (DAS) – is a notable exception. It has spent $240 million to date working on a cure, but is now at a crossroads. It can either abandon its program or invest another $55 million today. Unfortunately, the firm’s opportunity cost of funds is 8 percent and it will take another five years before final approval from the Federal Drug Administration is achieved and the product is actually sold. Expected (year-end) profits from selling the drug are presented in the accompanying table.

Year 1	Year 2	Year 3	Year 4	Year 5	Year 6	Year 7	Year 8	Year 9
$0	$0	$0	$0	$12,500,000	$14,000,000	$15,700,000	$18,300,000	$20,400,000

What is the net present value of the project?

Instruction: Enter your response rounded to the nearest penny (two decimal places). Use a negative sign (-) where appropriate.

$ ____________________

Should DAS continue with its plan to bring the drug to market, or should it abandon the project?

ABANDON or CONTINUE (choose)

Answer 1

Since $240 already spent is a sunk cost, it is ignored in cash flow analysis and only the incremental investment of $55 million is considered.

(i)

NPV ($) = -55,000,000 + 12,500,000 x P/F(8%, 5) + 14,000,000 x P/F(8%, 6) + 15,700,000 x P/F(8%, 7) + 18,300,000 x P/F(8%, 8) + 20,400,000 x P/F(8%, 9)

= -55,000,000 + 12,500,000 x 0.6806** + 14,000,000 x 0.6302** + 15,700,000 x 0.5835** + 18,300,000 x 0.5403** + 20,400,000 x 0.5002**

= -55,000,000 + 8,507,500 + 8,822,800 + 9,160,950 + 9,887,490 + 10,204,080

= -8,417,180.00

(ii) ABANDON

Since NPV < 0, the project should be abandoned.

**From P/F Factor table