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 4% 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 8% per year? The present value of the new drug is S milion. (Round to three decimal places.)

Explanation / Answer

We can use the present value of growing annuity to calculate the present value of the new drug The formula is as under, PV of growing annuity = [P/(r-g)] * [1 - {(1+g)/(1+r)}^n] PV of growing annuity = present value of the new drug = ? P = 1st year profit = $3 million r = rate of interest per year = 8% g = profit growth rate per year = 4% n = no.of years = 17 PV of growing annuity = [3/(0.08-0.04)] * [1 - {(1+0.04)/(1+0.08)}^17] PV of growing annuity = 75 * 0.473543 PV of growing annuity = 35.516 The present value of the new drug is $35.516 millions

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