As part of a broad effort to invigorate its pipeline and move more aggressively
ID: 3122884 • Letter: A
Question
As part of a broad effort to invigorate its pipeline and move more aggressively into biotechnology, GoodDrugs Inc. plans to set up a new division dedicated to developing biotherapeutic drugs and research technologies. The company expects to pay $120 million for set up costs of its new division now and $6 million in operating costs each year for the next 12 years. The company estimates that the new division will be able to generate annual revenue of $42 million 8 years from now. What is the conventional B-C ratio for this investment if the company's minimum attractive rate of return is 14% per year and the project life is 12 years? Textbook Title: Engineering Economy, 16th Edition
ISBN: 978-0133439274
Explanation / Answer
Charting of Inflows and Outflows:-
Year 1 2 3 4 5 6 7 8 9 10 11 12
Outflow 126 6 6 6 6 6 6 6 6 6 6 6
Inflow 42 42 42 42 42
To calculate the Benefit Cost ratio, we have to find out the Net Present Value of Outflow and Inflow at the rate of Company’s rate of return 14%
Hence,
NPV of Outflows=
126+6/(1.14)^1+6/(1.14)^2+6/(1.14)^3+6/(1.14)^4+6/(1.14)^5+6/(1.14)^6+6/(1.14)^7+6/(1.14)^8+6/(1.14)^9+6/(1.14)^10+6/(1.14)^11 = 158.71
NPV of Inflows:- 42/(1.14)^7+42/(1.14)^8+42/(1.14)^9+42/(1.14)^10+42/(1.14)^11= 65.69
Net NPV= 65.69-158.71 = -93.02
The NPV is negative, hence the Project is not viable.
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