Dr. Steven Goodman of Change Research Corporation was thrilled with the response he had received from drug companies for his latest discovery, a unique gene therapy that is an effective treatment for rheumatoid arthritis. The therapy has yet to pass rigorous Federal Drug Administration (FDA) testing and is still in the early stages of development, but the interest was intense. He received two offers, one from J&J and one from Novartis.
1. Johnson and Johnson Inc. (JNJ) - $3,000,000 now plus $100,000 per year from year 6 through 15. In addition, if the product does over $100 million in cumulative sales by the end of year 15, he will receive an additional $4,000,000. Dr. Goodman thinks there is an 80 percent probability this will happen.
2. Novartis Inc. (NOT) - 40 percent of the buyer's gross profit on the product for the next four years. Historically the gross profit margin is 60 percent. Sales in year 1 were projected to be $3,500,000 and then expected to grow by 40 percent per year.
Determine the present value of each offer assuming a 5% discount rate. Explain your calculations and identify your assumptions. Determine the risks and benefits to each offer and make a final recommendation to Dr. Goodman.