Acron is a large drug company. At the current time, the beginning of year 0, Acron is trying to decide whether one of its new drugs, Niagra, is worth pursuing. Niagra is in the final stages of development and will be ready to enter the market in year 1. The final cost of development, to be incurred at the beginning of year 1, is $9.3 million. Acron estimates that the demand for Niagra will gradually grow and then decline over its useful lifetime of 20 years. Specifically, the company expects its gross margin (revenue minus cost) to be $1.2 million in year 1, then to increase at an annual rate of 10% through year 8, and finally to decrease at an annual rate of 5% 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.8 Using an annual discount rate of 12% for the purpose of calculating NPV, the drug company wants to answer the following questions:
1. Is the drug worth pursuing, or should Acron abandon it now and not incur the $9.3 million development cost?
2. How do changes in the model inputs change the answer to question 1?
3. How realistic is the model?
Business Objectives To develop a model that calculates the NPV of Acron’s cash flows, to use this model to determine whether the drug should be developed further and then marketed, and to see how sensitive the answer to this question is to model parameters.
Excel Objectives To illustrate efficient selection and copying of large ranges and to learn Excel’s NPV function