A biotech project involves a pioneer venture stage to first prove the new technology in order toestablish
Question:
A biotech project involves a pioneer venture stage to first prove the new technology in order toestablish its viability for future commercial development of spin-off products. The pioneer ventureinvolves high initial costs and insufficient projected cash inflows. If the technology proves successful,subsequent product commercialization can be many times the size of the pioneer venture. The pioneerventure may be seen as the cost of the option to commercialize the technology in the future, if it pays to doso. If not, the company will abandon the project.
Consider the following data for a particular biotech project. The pioneer venture requires an initialinvestment outlay of I0 = $500 million, and expected cash inflows over 4 years of C1 = $100 million, C2 =$200 million, C3 = $300 million, and C4 = $100 million. The follow-on product commercialization stagewill become available in year 4, and is assumed to be 3 times the size of the pioneer venture. That is, I4 =$1,500 million, and the expected cash inflows over the subsequent 4 years are C5 = $300 million, C6 =$600 million, C7 = $900 million, and C8 = $300 million. The present value of the cash inflows expectedfrom the pioneer venture is discounted at the cost of capital of 20%. The risk-free rate is 10%. (All ratesare continuously compounded.
QUESTIONS:
1. With regard to the pioneer venture stage of this biotech project:
a. What is its NPV?
b. Should the company invest in the pioneer venture?
2. With regard to the follow-on product commercialization stage:
a. What is its NPV?
b. What is the value to the company if it were to commit to both stages (pioneer venture, subsequentproduct commercialization) of the project?
Systems analysis and design
ISBN: ?978-1118808177
5th edition
Authors: Alan Dennis, Barbara Haley Wixom, Roberta m. Roth