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 to produce a medication for headache pain. The second is a pill for headache and arthritis pain. Both products would be introduced at a price of $8.90 per package in real terms. The headache-only medication is projected to sell 2 million packages a year, while the headache and arthritis remedy would sell 3.5 million packages a year. Cash costs of production in the first year are expected to be $4.80 per package in real terms for the headache-only brand. Production costs are expected to be $5.35 in real terms for the headache and arthritis pill. All prices and costs are expected to rise at the general inflation rate of 3 percent. Either product requires further investment. The headache-only pill could be produced using equipment costing $16 million. That equipment would last three years and have no resale value. The machinery required to produce the broader remedy would cost $25 million and last three years. The firm expects that equipment to have a $1 million resale value (in real terms) at the end of Year 3. The company uses straight-line depreciation. The firm faces a corporate tax rate of 34 percent and believes that the appropriate real discount rate is 7 percent. Calculate the NPV for the headache pain reliever only. (Enter your answer in dollars, not millions of dollars. Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 1,234,567.89.) NPV $ Calculate the NPV for the headache and arthritis pain reliever. (Enter your answer in dollars, not millions of dollars. Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 1,234,567.89.) NPV $

Answer 1

	headache-only				headache and arthritis
Year	Initial Investment	Cash flow operations	Salvage Value	Total	Initial Investment	Cash flow operations	Salvage Value	Total
0	(16,000,000)			(16,000,000)	(25,000,000)			(25,000,000)
1		7,225,333		7,225,333		10,920,500		10,920,500
2		7,387,693.33		7,387,693		11,166,515.00		11,166,515
3		7,554,924.13	0	7,554,924		11,419,910.45	1000000	12,419,910
	NPV	$3,151,788.76			NPV	$4,764,194.35
	NPV=(Rate of discount, series of cash flows)

	UoM	headache-only	headache and arthritis
Initial Investment	$	16,000,000	25,000,000
Estimated Salvage Value	$	0	1000000
Depreciable Asset Cost	$	16,000,000	24,000,000
Useful Life	Years	3	3
Annual Depreciation	$	5,333,333.33	8,000,000.00
Year 1
Selling price Per unit	$	8.90	8.90
Production Cost Per Unit	$	4.80	5.35
Profit per Unit	$	4.10	3.55
Sales Per Year	Unit	2,000,000	3,500,000
Profit Per Year	$	8,200,000	12,425,000
Less: Depreciation	$	5,333,333.33	8,000,000.00
Taxable Income	$	2,866,666.67	4,425,000.00
Income Tax	$	974,666.67	1,504,500.00
Net Income	$	1,892,000.00	2,920,500.00
Cash Flow from Operations	$	7,225,333.33	10,920,500.00
Year 2
Selling price Per unit	$	9.17	9.17
Production Cost Per Unit	$	4.94	5.51
Profit per Unit	$	4.22	3.66
Sales Per Year	Unit	2,000,000	3,500,000
Profit Per Year	$	8,446,000	12,797,750
Less: Depreciation	$	5,333,333.33	8,000,000.00
Taxable Income	$	3,112,666.67	4,797,750.00
Income Tax	$	1,058,306.67	1,631,235.00
Net Income	$	2,054,360.00	3,166,515.00
Cash Flow from Operations	$	7,387,693.33	11,166,515.00
Year 3
Selling price Per unit	$	9.44	9.44
Production Cost Per Unit	$	5.09	5.68
Profit per Unit	$	4.35	3.77
Sales Per Year	Unit	2,000,000	3,500,000
Profit Per Year	$	8,699,380	13,181,683
Less: Depreciation	$	5,333,333.33	8,000,000.00
Taxable Income	$	3,366,046.67	5,181,682.50
Income Tax	$	1,144,455.87	1,761,772.05
Net Income	$	2,221,590.80	3,419,910.45
Cash Flow from Operations	$	7,554,924.13	11,419,910.45