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<h2 class="hd hd-2 unit-title">Timing Option Example</h2>
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Timing Option Example
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<p>Suppose we wish to purchase manufacturing facilities to produce a drug for which we just received FDA approval. The net profit per year is expected to be $200 million today (year 0), but next year, depending on the outcome of new pricing legislation, it will either rise to $300 million or fall to $100 million with equal probability and will remain the same thereafter. The cost of the facilities is $1.5 billion today or $1.65 billion next year. Should we purchase it today or wait a year? Assume a discount rate of 10% per year.</p>
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<h3 class="hd hd-2">Timing Option Example </h3>
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<h2 class="hd hd-2 unit-title">Pharmaceutical R&D Example 1</h2>
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Pharmaceutical R&amp;D Example 1
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Suppose a new drug has passed phase 1 clinical trials, and now requires a $5 million investment for a phase 2 clinical trial. This trial will take 2 years to complete and has a 60% chance of success. If the phase 2 trial is successful, a further $50 million is required for a phase 3 clinical trial and FDA review, which requires 3 years to complete and the probability of approval is 70%. Upon approval and at product launch, 3 years after the start of phase 3 trials, the forecasted net present value of future cash flows, which includes all drug sale revenues, production and marketing costs, is $150 million. Assuming a constant discount rate of 20% per year, what is the risk-adjusted net present value (rNPV) of this project?
<p><p style="display:inline">rNPV = $</p><div class="inline" tabindex="-1" aria-label="Question 1" role="group"><div id="inputtype_68dcb63264724b149ca29d89dfea4476_2_1" class=" capa_inputtype inline textline">
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<h3 class="hd hd-2">Pharmaceutical R&D Example 1 </h3>
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<h2 class="hd hd-2 unit-title">Pharmaceutical R&D Example 2</h2>
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Pharmaceutical R&amp;D Example 2
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Consider the previous example, except now the project manager learns more about the commercial potential of the drug after the phase 2 clinical trial. Suppose the forecasted net present value of future cash flows at the time of launch depends on the measured efficacy in phase 2. The upside scenario, where the drug has high efficacy, has an NPV at launch of $350 million. The neutral scenario, where the drug has low efficacy, has an NPV at launch of $50 million. And the downside scenario, where the drug has no efficacy and significant side effects, has an NPV of $0. The probabilities of the upside, neutral, and downside scenarios are 20%, 40%, and 40%, respectively. What is the risk-adjusted net present value of this project?
<p><p style="display:inline">rNPV = $</p><div class="inline" tabindex="-1" aria-label="Question 1" role="group"><div id="inputtype_49405bc535ce472fa69db80228e6c730_2_1" class=" capa_inputtype inline textline">
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<h3 class="hd hd-2">Pharmaceutical R&D Example 2 </h3>
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