ABC Pharmaceuticals is considering licensing AZ1024, anew drug with the potential to treat migraines, from AZ Biotech.Under the terms of the deal, ABC Pharmaceuticals would beresponsible for conducting clinical trials through approval. Ifapproved, they would also manufacture, market, and distribute thenew drug. AZ Biotech would receive an initial licensing fee,milestone payments as AZ1024 progressed through the approvalprocess, and a royalty on all future sales.

ABC Pharmaceuticals expects that the approval processwould take 4 to 7 years in total. Phase 1 would be a small study ofabout 50 people and would emphasize safety and dosage. ABCsmanagement team projects phase 1 would take 2 years, cost $20million, and have a 70% probability of success. In addition, a $2.5million initial licensing fee would be paid upfront to AZBiotech.

If successful, the compound would move to phase 2, anda $5 million milestone payment would be made to AZ Biotech. Thephase 2 trial would then enroll 300 subjects and take another 2years to complete. The goal of this phase would be to obtainpreliminary data on the efficacy of the compound in treatingmigraine. 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, itwould progress to phase 3, which would study a much larger group ofsubjects. Here, the costs and possible outcomes would depend on theoutcome of Phase 2. In particular, if AZ1024 demonstrated only weakefficacy, a much larger trial would be required to demonstrate astatistically significant effect. In this scenario, Phase 3 wouldcost $300 million, take 3 years to complete, and would have a 50%probability of success. Moreover, a $10 million milestone paymentwould 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 moderateefficacy in phase 2, the phase 3 trial could be designed with asmaller sample size. In this scenario, phase 3 would cost $200million, take 3 years to complete, and have an 80% probability ofsuccess. An additional milestone payment of $20 million would alsobe paid to AZ Biotech at the start of the trial, and another $20million would be paid if the trial was successful.

Finally, if AZ1024 demonstrated a strong effect inphase 2, the drug would be granted accelerated approval, and ABCPharmaceuticals would not be required to conduct a phase 3confirmatory trial to verify clinical benefit. Under this scenario,the drug would be immediately approved, and a $80 million milestonepayment would be made to AZ Biotech.

AZ1024 was projected to be highly profitable,especially if it were approved early with substantial clinicalbenefit and additional time for market exclusivity. If the drug wasapproved early, the commercialization profits would have a netfuture value at the moment of approval of $4 billion. If, however,the drug was approved after a phase 3 trial, the commercializationprofits would have a net future value at the moment of approval of$2 billion under the moderate efficacy scenario, and $1 billionunder weak efficacy scenario. Note that these profits are postroyalty fee payments.

2) What is AZ1024's rNPV from ABC Pharmaceutical'sperspective? Assume a discount rate of 10% per year between years4-7, 15% per year between years 2-4, and 20% per year between years0-2. (Note: Your answer should be expressed in units ofmillions of dollars.)

rNPV = $

3) What is the rNPV of the licensing agreement from AZBiotech's perspective? Assume a 5% royalty fee on any cash flowsABC Pharmaceutical receives from AZ1024 after approval, and adiscount rate of 10% per year between years 4-7, 15% per yearbetween years 2-4, and 20% per year between years 0-2.(Note: The commercialization profits for ABC Pharmaceuticalreported in the overview are post royalty fee payments. Your answershould be expressed in units of millions of dollars.)

rNPV = $

4)
For this problem assume a Phase 3 trial under the weak efficacyscenario is projected to cost $400 million instead of $300 million.What is AZ1024's rNPV from ABC Pharmaceutical's perspective? Assumea discount rate of 10% per year between years 4-7, 15% per yearbetween years 2-4, and 20% per year between years 0-2.(Note: Your answer should be expressed in units of millionsof dollars.)

rNPV = $