You work for a pharmaceutical company that has developed a new drug. The patent

Question

You work for a pharmaceutical company that has developed a new drug. The patent on the drug will last 17 years. You expect that the drug's profits will be $3 million in its first year and that this amount will grow at a rate of 6% per year for the next 17 years. Once the patent expires, other pharmaceutical companies will be able to produce the same drug and competition will likely drive profits to zero. What is the present value of the new drug if the interest rate is 10% per year?

The present value of the new drug is $_____ million.(Round to three decimal places.)

Explanation / Answer

Present value can be defined by using Gordon growth model:

Present value = income1/ (k-g)

where,

Income 1 = expected profit for the first year

K = required rate of return

g = growth rate per year

Present value = $ 3 million / (.10 - .06)

= $ 75

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