You are a manager at a pharmaceutical company, and one of your scientists has de

Question

You are a manager at a pharmaceutical company, and one of your scientists has developed a new statin that has no side effects. The initial cost to launch the drug will be $1,000,000. The revenue is projected to be produced according to one of two timelines, based on marketing. The first timeline has revenues of $100,000, $300,000, and $900,000 in years 1, 2, and 3, respectively. The second timeline has revenues of $900,000, $300,000, and $100,000 in years 1, 2, and 3, respectively.

(a) Provide the timelines for each scenario. Which timeline produces the greater ROR? Provide an explanation that describes what you observe.

(b) Assuming a hurdle rate of 15%, what is the NPV of each scenario.

(c) Determine the Benefit Cost Ratio and Present Value Ratio.

(d) Which scenario will you choose? Why?

Explanation / Answer

a. Rate of Return:

Internal rate of return: Timeline 1

Internal rate of return= R1+ (NPV at R1/( NPV at R1+ NPV at R2))(R2-R1)

=10%+14600/(14600+30800)(12-10)

=10%+14600/45400(2) = 10.64%

Internal rate of return: Timeline 1

Internal rate of return= R1+ (NPV at R1/( NPV at R1+ NPV at R2))(R2-R1)

=10%+141000/(141000+36800)(25-10)

=10%+141000/177800(15) = 21.895%

The Rate of return is higher in case of Timeline 2 Since it gives cash flows initial years as compared to Timeline 1

b. NPV at 15%-Timeline1

b. NPV at 15%-Timeline2

c. Benefit cost ratio= PV of cash inflows/ Pv of cash outfows

Timeline-1= 906000/1000000=0.906

Timeline-2=1075600/1000000=1.0756

Present value ratio= Present value of cash inflows after tax/ Pv of Cash inflows before tax

In this case we have not considered the tax both will be same

d. Timeline 2 is to be selected since IRR for the same is higher than 1 and based on Benefit cost ratio the Timeline with the Benefit cost ratio greater than 1 is to be selcted since it has greater revenue and less costs. So Tiemline 2 is to be selected

Thank You

Year 0 1 2 3 Initial cost (1000000) Revenues 100000 300000 900000 PVF@10% 1 0.909 0.826 0.751 Present value (1000000) 90900 247800 675900 NPV 14600 PVF@12% 1 0.893 0.797 0.712 Present Value (1000000) 89300 239100 640800 NPV (30800)

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