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 one year from now. The final cost of development, to be incurred at the beginning of year 1, is $15 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 $1.5 million in year 1, then to increase at an annual rate of 6% 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. (To simplify the model, taxes are ignored.) Using an annual discount rate of 7.5% for the purpose of calculating NPV, the drug company wants to answer the following questions:
Is the drug worth pursuing, or should Acron abandon it now and not incur the $15 million development cost?
How do changes in the model inputs change the answer