The medication industry has at least two types of firms. The first type is biotechnology companies that focus their efforts on research and development (R&D) of new drugs. The second type is pharmaceutical companies that also engage in developing new drugs, but spend considerable efforts in the production, supply, and marketing of drugs.
Suppose pharmaceutical company ABC invests $500 million in R&D for the purpose of finding a vaccine for malaria. The company estimates the probability of success at 10% over a five-year period. If a vaccine is successfully developed, the estimated benefits in terms of future cash flows to the company will be in the range of $10 billion to $20 billion.
Pharmaceutical company XYZ also invests $500 million, but directs the funds to be invested in the equity' of publicly traded biotechnology (inns that are all in the search for a malaria vaccine. Suppose that XYZ invests $50 million in each of 10 such biotechnology firms. In return, XYZ receives approximately 10% of the common equity' in each of these firms. XYZ accounts for these investments on a €œmark-to-market€ basis (meaning that changes in the biotechnology)' firms€™ stock prices are reflected in XYZ€™s assets and income).
Required:
a. How should ABC and XYZ account for each of their $500 million investments? Should they be capitalized as assets or expensed?
b. Suppose ABC successfully discovers a vaccine for malaria. How should it account for this discovery? If ABC were unsuccessful, how should the company account for this outcome?
c. Independent of (b), suppose one of the companies in which XYZ has an investment discovers a malaria vaccine, and the value of XYZ€™s investment increases to $2 billion. How should XYZ account for this outcome? Suppose the biotechnology company is unsuccessful and XYZ€™s investment becomes worthless. How should XYZ account for this outcome?
d. Using the following table, quantify the amount of revenue or income that would be recognized by ABC and XYZ in case of success or failure.

e. Comment on the differences between ABC and XYZ that you observe from part (d).

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ABC Vaccine success Vaccine failure