Question

You work for a pharmaceutical company that has developed a new drug. The patent on the drug will last for 17 years. You expect that the drug will produce cash flows of $10 million in its first year and that this amount will grow at a rate of 4% per year for the remaining 16 years. Once the patent expires, other pharmaceutical companies will be able to produce generic equivalents of your drug and competition will drive any future profits to zero. If the interest rate is 12% per year, then the present value of producing this drug is closest to:

Answer 1

Answer: $89,537,400

Explanation:

This represents the present value of a growing annuity because the amount received per year is growing by 4%.

$= First payment * \frac{1 - (\frac{1 + Annual growth rate)}{1 + Annual interest rate)}^{no. of years} }{Annual interest rate - Annual growth rate} \\\\= 10,000,000 * \frac{1 - (\frac{1 + 0.04)}{1 + 0.12)}^{17} }{0.12 - 0.04}\\\\= 10,000,000 * 8.95374\\\\= 89,537,400$

= $89,537,400