# Calculation Of NPV IRR And Payback Period For A Firm

Question

Neo Pharmaceuticals is a start-up pharmaceutical company focused on the development and commercialization of non-steroidal anti-inflammatory drugs world-wide. The company recently obtained FDA approval for one of its new drugs, vacuus poena and must now decide between a product launch in Europe or the United States. Since the company has spent the majority of its funding on the development of vacuus poena, it can only afford to market the new product in one geographic region. The company estimates that it will cost \$250 million to launch the product in the U.S. and \$50 million to establish a smaller presence in Europe. Management’s required payback period for this type of investment is 3.5 years. The Vice President of Marketing and Sales has estimated the future cash inflows by region in the table below.

Projected Cash Flow By Region

For R Vacuus Poena (\$ millions)

 Region IRR Launch Costs 2011 2012 2013 2014 2015 US 28% \$250 \$ 35.40 \$80.76 \$129.80 \$160.92 \$176.15 Europe 37% \$50 \$17.70 \$22.28 \$24.65 \$31.03 \$32.04

• Calculate the company’s cost of capital using the following assumptions: i) the company can borrow money at 5% interest; ii) shareholders expect a 20% return on their investment; iii) 40% of the company is financed by debt and 60% by equity.

Cost of Capital =

• The CFO of the company has mandated that all investment proposals use a hurdle rate equal to the cost of capital plus 4%. What is the net present value (NPV) for each region? Show all work used to arrive at answers.

NPVUS=

NPVEU=

• What is the exact payback period for each region? Show all work used to arrive at answers. Round payback periods to one decimal place.
• Which region would the company choose for a product launch if the decision were based solely on the payback period method?
• Which region would the company choose for a product launch if the decision were based solely on the IRR method?
• Which region would the company choose for a product launch if the decision is based on the NPV method? Explain why.

Summary

The question belongs to Finance and it discusses about calculating NPV, IRR, Payback period, etc for a firm.

Total Word Count 271

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