First of part of this report is to explain how we determine the NPV for both the

successful and the unsuccessful test in our study case.

NPV is defined as net present value of a project or investment as the difference
between the present value of its benefits and the present value of its costs (E
q. 3.1 on P. 66 in [1]):
NPV=PV (benefits)-PV (costs)
First of all, we start with determining the present value of the free cash flow
for each of the year (t = 1 to 5) by considering t-year discount factor, accordi
ng to Eq. 8.7 on P. 244 in [1]:
PV(?FCF?_t )= ?FCF?_t/?(1+r)?^t =?FCF?_t1/?(1+r)?^t
where r is cost of captial and 1/?(1+r)?^t is so called t-year discount facto
r
In our case, the starting time from t=1, which is the starting point of the test
, for both the successful and the unsuccessful test.
The detailed calculation for each year discount factor and PV of cash flow is gi
ven in the attached excel-file.
Finally, given the initial values in our case, the NPV is the sum of the negativ
e value of the investment and the PV of each year cash flow. The NPV for the suc
cessful is 3433.746 million dollar (>0) while for the unsuccessful is -93.96 mil
lion dollar (<0).
The expected pay-off is then calculated by considering the probability for each
case. However, since the NPV is negative for the unsuccessful case, the pay-off
should hence be considered as zero and can be ignored.
Expected payoff (t=1)= 60%?NPV?_successful+40%0=2060.25 million
The value of the test starting at t=0, is the sum of cost incurred in preliminar
y phase + present value of expected pay off at t =1:
Value of test= cost of test+((Expected payoff at t=1)/(1+r))= -1000+2060.25/1.1=
872.95million
A financial manager s job is to make decisions on behalf of the firm s investors. Ho
w to make decisions that increase the value of the firm to its investors is the
key. In principle, the idea is simple and intuitive. For good decisions the bene
fits exceed the costs.
The first step in decision making is to identify the costs and benefits of a dec
isions. The next step is to quantify these costs and benefits. In order to compa
re the costs and benefits, we need to evaluate them in the same terms cash today
, by applying the discount procedure, which means a dynamic investment analysis.
When we compute the value of a cost or benefit in terms of cash today, we refer
to it as the present value (PV).
In our case, the calculated NPV is seen as dynamic due to the discounting proced
ure. Because NPV is expressed in terms of cash today, it simplifies decision mak
ing. As long as we have corr