Question

You are a manager at a pharmaceutical company, and one of your scientists has developed a new statin that has no side effects. The initial cost to launch the drug will be $1,000,000. The revenue is projected to be produced according to one of two timelines, based on marketing. The first timeline has revenues of $100,000, $300,000, and $900,000 in years 1, 2, and 3, respectively. The second timeline has revenues of $900,000, $300,000, and $100,000 in years 1, 2, and 3, respectively.

(a) Provide the timelines for each scenario. Which timeline produces the greater ROR? Provide an explanation that describes what you observe.

(b) Assuming a hurdle rate of 15%, what is the NPV of each scenario.

(c) Determine the Benefit Cost Ratio and Present Value Ratio.

(d) Which scenario will you choose? Why?

Answer 1

a. Rate of Return:

Internal rate of return: Timeline 1

Year	0	1	2	3
Initial cost	(1000000)
Revenues		100000	300000	900000
PVF@10%	1	0.909	0.826	0.751
Present value	(1000000)	90900	247800	675900
NPV	14600
PVF@12%	1	0.893	0.797	0.712
Present Value	(1000000)	89300	239100	640800
NPV	(30800)

Internal rate of return= R1+ (NPV at R1/( NPV at R1+ NPV at R2))(R2-R1)

=10%+14600/(14600+30800)(12-10)

=10%+14600/45400(2) = 10.64%

Internal rate of return: Timeline 1

Year	0	1	2	3
Initial cost	(1000000)
Revenues		900000	300000	100000
PVF@10%	1	0.909	0.826	0.751
Present value	(1000000)	818100	247800	75100
NPV	141000
PVF@25%	1	0.80	0.64	0.512
Present Value	(1000000)	720000	192000	51200
NPV	(36800)

Internal rate of return= R1+ (NPV at R1/( NPV at R1+ NPV at R2))(R2-R1)

=10%+141000/(141000+36800)(25-10)

=10%+141000/177800(15) = 21.895%

The Rate of return is higher in case of Timeline 2 Since it gives cash flows initial years as compared to Timeline 1

b. NPV at 15%-Timeline1

Year	0	1	2	3
Initil	(1000000)
Cash flows		100000	300000	900000
PVF@15%	1	0.870	0.756	0.658
Present Value	(1000000)	87000	226800	592200
NPV	(94000)

b. NPV at 15%-Timeline2

Year	0	1	2	3
Initil	(1000000)
Cash flows		900000	300000	100000
PVF@15%	1	0.870	0.756	0.658
Present Value	(1000000)	783000	226800	65800
NPV	75600

c. Benefit cost ratio= PV of cash inflows/ Pv of cash outfows

Timeline-1= 906000/1000000=0.906

Timeline-2=1075600/1000000=1.0756

Present value ratio= Present value of cash inflows after tax/ Pv of Cash inflows before tax

In this case we have not considered the tax both will be same

d. Timeline 2 is to be selected since IRR for the same is higher than 1 and based on Benefit cost ratio the Timeline with the Benefit cost ratio greater than 1 is to be selcted since it has greater revenue and less costs. So Tiemline 2 is to be selected