Throughout the question, assume an annual discount rate of 10%.

ADC Inc. is considering making a new drug at year 0 at an initial cost of $150 million. The drug's sales revenue will depend on details of a government regulation announced in year 1. With a 90% probability, the drug will bring an annual income of $50 million for the next seven years (year 1 to year 7). With a 10% probability, the drug will bring an annual income of $25 million for the next seven years (year 1 to year 7).

Since there is no uncertainty in year 1, ADC Inc. could wait for a year and only launch the project when the outcome is favorable. If it waits for a year, the project's up-front cost in year one will remain at $150 million, and the subsequent cash flows will remain at $50 million or $25 million per year, depending on the regulation. However, if ADC decides to wait, the subsequent cash flows will be received only for six years (year 2 to year 7).

(a)  What is the expected NPV of the project if the company launches the project at period 0?

(b)  What is the expected NPV of the option to wait for one year?

Answer rating: 100% (QA)

a To calculate the expected NPV of the project if the company launches it at period 0 we need to cal... View the full answer