Toward a Fuller Understanding of Present Value End of Appen

Toward a Fuller Understanding of Present Value — End of Appendix Problem

2. The drug company Pfizer is considering whether to invest in the development of a new cancer drug. Development will require an initial investment of $10 million now; beginning one year from now, the drug will generate annual profits of $4 million for three years.

At an interesest rate is 12%, what is the net present value of the investment?

$

.

At an interesest rate is 8%, what is the net present value of the investment?

$

Given the net present values, Pfizer should develop the drug if

Solution

ANSWER:

Initial investment = $10,000,000

Annual profit = $4,000,000

n = 3 years

1) when i = 12%

pw = initial investment + annual profit(p/a,i,n)

pw = -10,000,000 + 4,000,000(p/a,12%,3)

pw = -10,000,000 + 4,000,000 * 2.402

pw = -10,000,000 + 9,608,000

pw = -$392,000

2) when i = 8%

pw = initial investment + annual profit(p/a,i,n)

pw = -10,000,000 + 4,000,000(p/a,8%,3)

pw = -10,000,000 + 4,000,000 * 2.577

pw = -10,000,000 + 10,308,000

pw = $308,000

given the present values , he should develop the drug when the interest rate is 8% as at 8% , the net present worth is $308,000.