Additional Problem #2: F inn Pharmaceutical Innovation Consider the situation, similar to what we saw in class, where a drug manufacturer is considering developing a drug, delivered in pill form, to cure swine u. There is currently no other drug in the market, so the company will capture the whole market. Assume that the company has scientists who have developed 4 potential drugs to cure swine u during their initial R & D. From the perspective of the company trying to decide which drugs to invest in, all drugs are equivalent before they begin investment. The company knows that it will learn information through the clinical trial process and that some drugs will be unsuccessful. The company knows that the outcome probabilities for each of the 4 drugs are: Outcome Chance of Outcome Outcome (Millions 5) Drops out pre-clinical trials 20% -3 Drops out after Phase I 20% -10 Drops out after Phase II 20% -30 Drops out after Phase III 20% -100 Makes it to market 20% P -100 {P deter. below) These probabilities reect the actual total probability a drug drops out .t reaches a given phase and are n_ot conditional probabilities (which would give chance of success conditional on reaching each phase). As in the example in class, the nancial outcomes listed are cumulative nancial outcomes for reaching a phase. So, a drug that drops out after phase 3 loses 100 million dollars, not 143 million dollars (the sum of all numbers up to that point.) Prot P if the drug is successful is determined in the problem below. For most of the problem consider the case where the company is deciding whether or not to invest in all 4 drugs or in 0 drugs. a) What is the probability that all 4 drugs are unsuccessful if the company pursues all 4? b} What is the expected cost of each dmg conditional on being omits-cosy\"? c} What is the rm payoff for the case where the firm invests in all drugs but all dmgs are unsuccessful? As in class, consider the case where the rm can only derive value from one successful drug. if two drugs are successful, the second drug thus incurs the costs of making it to market, but provides no extra payoff once making it there. d) Conditional on at least one of the four drugs the firm investigates being successful, what is the expected cost incurred in total for all four drugs (including the successful drug}? e) Assume that the payoff in the market for a drug is P. We will gure out exactly what this payoff is later in the problem. As a function of P. write down the expected overall value from investing in all 4 drugs (vs. the case of no investment. Now. let's turn to the market outcomes for a drug if it's success-ll. We want to gure out what P is. Assume that the yearly demand curve for the drug is: P=4oo-.5Q The number of consumers in the population is Q = 800. Assume for prot calculations that quantity is measured in thousands, so that a quantity of 800 as used in the demand function actually represents a quantity of 800,000 people. Assume that the marginal cost of producing the drug once it reaches the market is 0. Consider the case where the drug manufacturer has a patent for 1 year in the market. after which other drugs can enter and prots go to 0. 1} For the year the rm is a monopolist. what are the price, quantity. and prots earned assuming the rm is prot maximizing? Drainr out a graph with demand, marginal revenue, and prots. g} For the one year market, what is the total value from the investment in all 4 drugs (incorporating the market payoff now)? Now consider rm discounting. Assume that rms have a yearly discount rate of 5. Assume that 5 = 0.8. h) If the clinical trial phase is one year long (not discounted) and the one year the drug is on the market is discounted 5, what is the value of the investment in all 4 drugs now? i) If the company's patent now grants them 5 years of monopoly power instead of 1, what is the value of the investment? Assume that year one is still discounted at 5 but that each year after that is discounted (as usual) by 5 to the tpower, where t is the year in question. Now, think about the case where the rm's clinical trial process take 8 years (as is normal) instead of occurring in period 0. For simplicity, let's assume that all costs are discounted at 54 and that the rst year of monopoly prots are discounted at 59 . Subsequent years are discounted by more, as in part i) above. j) Now what is the value of the firm's investment if the patent lasts for 5 years after the drug reaches the market? k) What is the firm's investment value if the patent lasts for 10 years after the drug reaches the market with the same discount factor of 0.8? What is the firm's investment value if the patent lasts for 10 years, but the discount factor is now 0.95? Finally, assume now that there is actually a second competitor drug that enters the market immediately together with the successful drug of this rm (if the rm has a successful drug). Consider again the case with no discounting and a one year post market patent (meaning it is only you, and this other rm with their own patent in the market). Now, because of competition, your residual consumer demand for the drug is: P=200-.8Q Residual demand can be treated as if the rm were a monopolist, so you can nd prots by setting MR = MC. Residual demand measures demand as if the rm were a monopolist, as you can note it is lower than the true monopolist case. 1) Using this residual demand, what is the value of investment in all 4 drugs for the fn'm