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Acron is a large pharmaceutical company. At the current time, Acron is trying to decide whether one of its new drugs, Tivra, is worth pursuing. Tivra is in the final stages of development and will be ready to enter the market in year one. The final cost of development, to be incurred at the beginning of year one, is $8.9 million. Acron estimates that the demand for Tivra will gradually grow and then decline over its useful lifetime of 20 years. Specifically, the company expects the annual profit (attributable to Tivra) to be $1.1 million in year 1. Annual Tivra profit is expected to increase at an annual rate of 10% for 7 years (through year 8) and finally to decrease at an annual rate of 4% through year 20. Acron wants to develop a spreadsheet model of its 20-year cash flows, assuming its cash flows, other than the initial development cost, are incurred at the ends of the respective years. Using an annual discount rate of 11% for the purpose of calculating NPV, the drug company wants to answer the following problems:"

a) Based on these assumptions, is the drug worth pursuing or should Acron abandon it now and avoid the $8.9 million development cost? describe your answer. They should pursue the drug because they will end up making a profit.

b) How do changes in the model inputs change the answer the company's decision? Specifically, what if the rate of profit increase varies between 2% and 15% (in 1% increments) and the discount rate ranges from 10% to 20% (in 1% increments)? Identify (shade/highlight) circumstances where this project should move forward.

c) Based on the original assumptions, what is the internal rate of return associated with this drug project?
i) Estimate the internal rate of return from the table in part b. IRR is approximately ________________%
ii) Using the IRR formula or GoalSeek, find the exact IRR to two decimal places. IRR=________________%

Microeconomics, Economics

  • Category:- Microeconomics
  • Reference No.:- M939207

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