AZRE is a mid-size pharmaceutical firm specializing in drugs to manage pain. They currently have a drug, NoMoPane, which is ready for (Phase III) clinical trials.

The clinical trials will cost AZRE a total of $100 million in present value. If they make this investment, there is a 20 percent chance that NoMoPane will be successful in obtaining FDA approval. If NoMoPane is not approved, you may assume that it is worthless. If the drug is approved, AZRE believes it has a 60% chance of being available only as a "scheduled substance" which requires special handling in pharmacies and hospitals and would greatly limit sales. (Powerful narcotics like morphine are scheduled substances.) If NoMoPane is a scheduled substance, the present value of the drug is estimated to be $90 million. If NoMoPane is not a scheduled substance, it will be available more broadly by prescription and the present value of the drug is estimated at $1000 million.

You may assume AZRE is risk neutral for Questions 1 to 5 and the objective is to maximize expected profit.

a. What is the expected profit if AZRE decides to invest in trials (in terms of million dollars)

b. Should AZRE invest in trials? (1pt)

Group of answer choices

Yes

No

c . If they do invest in the clinical trials, what is the probability that they will have a positive present value? (2pts)

d. There is some debate at AZRE about the probability of obtaining FDA approval and whether 20 percent is the right number to assume. At what probability would your recommendation in part b) change? [You may assume that the probability of NoMoPane being a scheduled substance does not change if you change the probability obtaining FDA approval.] (2pts)

e. Suppose you could find out whether NoMoPane would be approved by the FDA, before investing in the trials. How much would this perfect information be worth (in terms of million dollars)? [This information would not affect the probability of NoMoPane being a scheduled substance.] (2pts)

f. Now assume AZRE is risk averse and uses an exponential utility function.

If the risk tolerance parameter is $200 Million, does the recommendation in (2) change? (0.5pts)

Group of answer choices

Yes

No

g. Why or why not?