Toprovideacontrast,thenetpresentvalueofthisprojectis
only $547 million.
Thetime premiumof$360 milliononthis option($907 −
$547)suggeststhatthefirmwillbebetteroffwaitingrather
than developing the drug immediately, the cost of delay
notwithstanding. However, the cost of delay will increase
over timeand makeexercise (development)morelikely in
future years.
Toillustrate,wevaluedthecalloption,assumingthatallof
theinputs,otherthanthepatentlife,remainunchanged.For
instance, assumethat thereare 16 years leftonthepatent.
Holding all elseconstant, thecost of delay increasesas a
result of the shorter patent life.
Thedeclineinthepresentvalueofcashflows(whichisS)
andtheincreaseinthecostofdelay(y)reducetheexpected
valueofthepatent.Figure12.2graphstheoptionvalueand
the net present value of the project each year.
FIGURE 12.2 Option Value versus Net Present Value of
Patent