ABC Pharmaceuticals is considering licensing AZ1024, a new drug with the potential to treat migraines, from AZ Biotech. Under the terms of the deal, ABC Pharmaceuticals would be responsible for conducting clinical trials through approval. If approved, they would also manufacture, market, and distribute the new drug. AZ Biotech would receive an initial licensing fee, milestone payments as AZ1024 progressed through the approval process, and a royalty on all future sales. ABC Pharmaceuticals expects that the approval process would take 4 to 7 years in total. Phase 1 would be a small study of about 50 people and would emphasize safety and dosage. ABCs management team projects phase 1 would take 2 years, cost $20 million, and have a 70% probability of success. In addition, a $2.5 million initial licensing fee would be paid upfront to AZ Biotech. If successful, the compound would move to phase 2, and a $5 million milestone payment would be made to AZ Biotech. The phase 2 trial would then enroll 300 subjects and take another 2 years to complete. The goal of this phase would be to obtain preliminary data on the efficacy of the compound in treating migraine. ABC Pharmaceuticals estimates there would be a 5%, 15%, and 20% probability that this trial would show a strong, moderate, or weak effect, respectively. Not including the milestone payment, phase 2 is projected to cost $60 million. If the drug demonstrates effectiveness in phase 2, it would progress to phase 3, which would study a much larger group of subjects. Here, the costs and possible outcomes would depend on the outcome of Phase 2. In particular, if AZ1024 demonstrated only weak efficacy, a much larger trial would be required to demonstrate a statistically significant effect. In this scenario, Phase 3 would cost $300 million, take 3 years to complete, and would have a 50% probability of success. Moreover, a $10 million milestone payment would be paid to AZ Biotech at the start of the trial, and another $20 million would be paid if the trial was successful. On the other hand, if AZ1024 demonstrated moderate efficacy in phase 2, the phase 3 trial could be designed with a smaller sample size. In this scenario, phase 3 would cost $200 million, take 3 years to complete, and have an 80% probability of success. An additional milestone payment of $20 million would also be paid to AZ Biotech at the start of the trial, and another $20 million would be paid if the trial was successful. Finally, if AZ1024 demonstrated a strong effect in phase 2, the drug would be granted accelerated approval, and ABC Pharmaceuticals would not be required to conduct a phase 3 confirmatory trial to verify clinical benefit. Under this scenario, the drug would be immediately approved, and a $80 million milestone payment would be made to AZ Biotech. AZ1024 was projected to be highly profitable, especially if it were approved early with substantial clinical benefit and additional time for market exclusivity. If the drug was approved early, the commercialization profits would have a net future value at the moment of approval of $4 billion. If, however, the drug was approved after a phase 3 trial, the commercialization profits would have a net future value at the moment of approval of $2 billion under the moderate efficacy scenario, and $1 billion under weak efficacy scenario. Note that these profits are post royalty fee payments.

Build a decision tree for ABC Pharmaceuticals that shows the cash flows and probabilities at all stages of the regulatory approval process. Your tree should have 7 outcomes with 4 failures and 3 successes. Assuming the project is not strategically abandoned early, what is the probability that AZ1024 is launched: (Note: Your answer should be a number in percentage form. Do not enter '%'.)

• In year 4?

• In year 7, with a commercialization value of $2 billion?

  In year 7, with a commercialization value of $1 billion?

What is the probability that AZ1024 fails to reach the market? (Note: Your answer should be a number in percentage form. Do not enter '%'.)