Approximately 14 million Americans are addicted to drugs and alcohol. The federa

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 $280 million to date working on a cure, but is now at a crossroads. It can either abandon its program or invest another $75 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.

Explanation / Answer

Compare the net present value of the cost and benefits. Here the time period for the cost is 9 years

Net present value of profits/benefits will be

= $15,400,000(P/F, 8%, 5) + $17,500,000(P/F, 8%, 6) + $19,100,000(P/F, 8%, 7) + $22,700,000(P/F, 8%, 8) + $25,900,000(P/F, 8%, 9)

= $15,400,000*0.6806 + $17,500,000*0.6302 +$19,100,000*0.5835 + $22,700,000*0.5403 + $25,900,000*0.5002

= $57,874,580 or $57.8 million

And the Net present value of cost is $75 million . Since cost> benefits,  DAS should abandon the project

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