Question 5. A small biotechnology company has developed a bum treatment that has commercial potential. The company has to decide whether to produce the new compound itself or sell the rights to the compound to a large drug company. The payoffs from each of these courses of action depend on whether the treatment is approved by the Food and Drug Administration (F DA), the regulatory body in the United States that approves all new drug treatments. (The FDA bases its decision on the outcome of tests of the drug's effectiveness on human subjects.) The company must make its decision before the FDA decides. Here are the payoffs the drug company can expect to get under the two options it faces: Decision Produce Outcome Probability Sell the Rights Yourself FDA approves 0.20 $10 $50 FDA does not approve 0.80 $ 2 -$10 (payoffs are in millions of dollars) Assuming that the biotechnology company acts as a risk-neutral decision maker, what action should it choose? What is the expected payoff associated with this action? What is the value of perfect information? Answer: The expected payoff for \"Sell rights\" is 3.6. The expected payoff for \"Produce yourself\" is 2. Therefore, the risk-neutral company should sell the rights. Calculating the value of perfect information: Outcome Prob ability Action/Payoff Expectation FDA approves 0.20 Produce/ $50 $10 FDA does not approve 0.80 Sell/ $2 $1.6 Expected payoff with perfect information 1 1.6 Expected payoff without information 3 .6 Value of perfect information 8