2. Spicer Drug Development Process 60 points Spicer Pharmaceuticals exploring the possibility of developing a new drug, Mentalox, which has shown promise in the treatment of two different ailments: depression and migraines. Drug development in US typically goes through 3 phases of clinical approval process at FDA. In Phase I, the drug is given to a small number of healthy volunteers to test for its safety. This usually takes about 18 months. In Phase II, a larger number of patients are tested to determine if the drug is effective in treating a certain condition and to measure its potential side effects. This usually takes about 2.5 years. Finally, in Phase III, a large number of patients are tested for safety and efficacy. This phase takes about 3 years to complete. Mentalox is currently in pre-clinical development and is ready to enter the first of the three phases of clinical approval process required by FDA. After a comprehensive internal evaluation process, Spicer has collected information regarding the costs and risk associated with the R&D process. These details are given below: . Phase 1: In this phase, Mentalox would be administered to 50-100 healthy people to determine if the drug is safe enough to continue into the efficacy stages of clinical testing. This phase is expected to cost $60 million and there is only a 50% chance that Mentalox would successfully complete it. . Phase II: The primary purpose of this phase is to determine the efficacy of Mentalox for treating depression and/or migraines and to document any side effects. To complete the efficacy tests, Mentalox would have to demonstrate a statistically significant impact on patients suffering from either or both of depression and migraines. The R&D team estimates a 15% probability that Phase II would show that Mentalox would be efficacious for treating only depression and a 10% probability for treating only migraine. There is also a 5% probability that it would be efficacious for both depression and migraine treatments. Phase II is expected to cost $80 million. . Phase III: The third phase is much larger in scope and scale, and would require testing to be conducted on 1000-5000 volunteers to determine safety and efficacy in long term use. Because of the number of volunteers and nature of testing, this is the most costly of the phases. Also, the costs and probabilities of success depend on the outcome from Phase II. - If Mentalox was effective for only depression, Phase III trials would cost $400 million. Subsequent to the trials for this scenario, there is an 85% chance it would be approved for treating depression. - If Mentalox was shown to be effective for only migraine during Phase II, the Phase III trials would cost $300 million, and have a 75% chance of approval. - More specialized trials would be required to determine efficacy of the drug if Mentalox was shown to be effective for both treatments (depression and migraine) during Phase II trials. The total cost of the Phase III clinical trials for this scenario is expected to be $1bn. After the trials, there is a 70% chance that the FDA would be approve the drug for both depression and migraine treatments. Also, there was a 15% chance that the drug would be approved only for depression, and a 5% chance that it is would be approved only for migraine. Finally, the probability of complete failure is 10%. In this case, the drug is not approved for treating either depression or migraine. Spicer would be able to generate substantial potential profits, especially if Mentalox was effective both as a treatment for depression and migraine. If the drug were approved only for the treatment of depression, it would cost $500 million to launch, and had a commercialization value of $2.5 billion. If it were only approved for treating migraine, it would cost $200 million to launch, and would have a value of $700 million. However, if Spicer could launch the drug for treating for both indications, it would cost $750 million to launch and have a value of $5 billion. Answer the following questions based on the description above. All cash flows, including capital expendi- tures, are expressed as after-tax present values discounted to time zero. 1. Using the data from the case, analyze the decision making setup for Spicer and calculate the value that they can generate by going through the development process? 15 points 2. How would your analysis change if the costs of launching (in the commercialization phase) of Men- talox for migraine were $400 million instead of $200 million as given in the case? Determine the correspond value from the development process. 15 points 3. The Spicer R&D team believes that it is equally likely that the launch costs of Mentalox for migraine could be 400mn or 200mn (probability of each of these cases is 50%). Now suppose Spicer could conduct a separate analysis to accurately estimate the launch costs of Mentalox for migraine treatment before the beginning of Phase 1. What is the maximum cost that Spicer should incur to conduct such an analysis? 15 points 4. Suppose the analysis can be delayed until the start of Phase III (i.e. after the end of Phase II but before the beginning of Phase III). What is the maximum cost that Spicer would be willing to incur under this scenario? 15 points 5. [Bonus Question - no partial credit] Compare the amounts they were willing to spend for the analysis in Part 3 and Part 4 above. Are they same or different? Why? 5 points