A Pharmaceutical Company Is Considering Producing a Generic Drug

Essay

A pharmaceutical company is considering producing a generic drug. If it spent $50 million today, the pharmaceutical company could begin selling its drug in one year. The interest rate is 10% and all returns last until the end of time.
a. Suppose the drug will earn $8 million a year. What is the net present value of producing the drug?
b. Suppose the drug will earn $4 million a year. What is the net present value of producing the drug?
c. Suppose there is a 50% probability that the drug will earn $8 million a year and a 50% probability that it will earn $4 million a year. What is the expected net present value of producing the drug?
d. Suppose the pharmaceutical company waits one year to learn whether it will earn $8 million or $6 million a year. If $8 million a year, it will spend $50 million to bring the drug to market. What is the net present value of bringing the drug to market if the company waits one year and finds out that it will earn $8 million?
e. What is the option value of waiting one year to determine the profitability of the drug?