Question

After extensive medical and marketing research, Pill, Inc., believes it can penetrate the pain reliever market. It is considering two alternative products. The first is a medication for headache pain. The second is a pill for headache and arthritis pain. Both products would be introduced at a price of $8.50 per package in real terms. The headache-only medication is projected to sell 3 million packages a year, whereas the headache and arthritis remedy would sell 4.7 million packages a year. Cash costs of production in the first year are expected to be $4.25 per package in real terms for the headache-only brand. Production costs are expected to be $4.80 in real terms for the headache and arthritis pill. All prices and costs are expected to rise at the general inflation rate of 2 percent.

  

Either product requires further investment. The headache-only pill could be produced using equipment costing $27 million. That equipment would last three years and have no resale value. The machinery required to produce the broader remedy would cost $30 million and last three years. The firm expects that equipment to have a $1,100,000 resale value (in real terms) at the end of Year 3.

  

The firm uses straight-line depreciation and has a tax rate of 23 percent. The appropriate real discount rate is 8 percent.

  

b.	Calculate the NPV for headache and arthritis pain reliever. (Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, rounded to 2 decimal places, e.g., 1,234,567.89.)

Answer 1

Following formulas are used for calculation:

NPV is calculated as = NPV(discount rate, Cash flows from t=1 onwards) + Initial Investment at t=0