Model Answer
0 min readIntroduction
Investment decisions in the pharmaceutical industry are inherently risky due to the high costs of research and development (R&D) and the uncertainty of success. Developing a new drug can take over a decade and cost billions of dollars, with a significant failure rate. Therefore, a robust financial analysis, incorporating probability and potential returns, is crucial before committing substantial resources. This case presents a simplified scenario of a new drug development project, requiring an assessment of its financial viability based on the provided data. The core principle guiding such decisions is maximizing expected value while managing risk.
Expected Monetary Value (EMV) Calculation
The EMV is a statistical technique used to determine the average outcome of a decision when the probability of different outcomes is known. In this case, it helps assess whether the potential benefits of developing the drug outweigh the costs.
The formula for EMV is: EMV = Σ (Probability of Outcome * Value of Outcome)
Here, we have two possible outcomes:
- Success: 60% probability, resulting in a revenue of ₹1,00,000 (assuming the cost is recovered and profit is generated).
- Failure: 40% probability, resulting in a loss of ₹1,00,000 (the R&D cost).
Therefore, the EMV is calculated as follows:
EMV = (0.60 * ₹1,00,000) + (0.40 * -₹1,00,000)
EMV = ₹60,000 - ₹40,000
EMV = ₹20,000
Based on this calculation, the project has a positive EMV of ₹20,000. This suggests that, purely from a financial perspective, the firm *should* proceed with the drug development.
Risk Assessment and Mitigation
While the EMV is positive, it's crucial to acknowledge the inherent risks. The 60% success rate is an estimate and could be inaccurate. Several factors can contribute to the failure of drug development, including:
- Technical Challenges: The drug may prove ineffective or have unacceptable side effects during clinical trials.
- Regulatory Hurdles: Obtaining approval from regulatory bodies like the Drugs Controller General of India (DCGI) can be lengthy and uncertain.
- Market Competition: Competitors may develop similar drugs, reducing the market potential.
- Intellectual Property Risks: Patent challenges or infringement issues could arise.
Mitigation strategies include:
- Thorough Due Diligence: Conducting comprehensive preclinical and clinical trials to assess the drug's efficacy and safety.
- Robust Intellectual Property Protection: Securing strong patents to protect the drug's exclusivity.
- Market Research: Conducting detailed market analysis to refine the market potential assessment.
- Contingency Planning: Developing alternative plans in case of setbacks or failures.
Alternative Strategies
Instead of committing the entire ₹1,00,000 upfront, the firm could consider a phased development approach:
- Phase 1: Initial Research (₹20,000): Focus on preliminary studies to validate the drug's target and mechanism of action. A 'go/no-go' decision point would be established based on the results.
- Phase 2: Preclinical Trials (₹30,000): If Phase 1 is successful, proceed with preclinical trials to assess the drug's safety and efficacy in animal models.
- Phase 3: Clinical Trials (₹50,000): If Phase 2 is successful, initiate clinical trials in humans.
This phased approach reduces the risk of losing the entire investment if the drug fails at an early stage. It also allows for more informed decision-making at each stage, based on the latest data. Another strategy is to seek partnerships or collaborations with other pharmaceutical companies to share the costs and risks.
Sensitivity Analysis
Performing a sensitivity analysis is crucial. This involves changing the key variables (probability of success, market potential) to see how they impact the EMV. For example, if the probability of success drops to 50%, the EMV becomes zero. This highlights the importance of accurate estimations.
| Probability of Success | Market Potential (₹) | R&D Cost (₹) | EMV (₹) |
|---|---|---|---|
| 60% | 1,00,000 | 1,00,000 | 20,000 |
| 50% | 1,00,000 | 1,00,000 | 0 |
| 70% | 1,00,000 | 1,00,000 | 30,000 |
Conclusion
In conclusion, while the initial EMV calculation suggests proceeding with the drug development, a comprehensive risk assessment and consideration of alternative strategies are essential. A phased development approach, coupled with robust risk mitigation measures and sensitivity analysis, would enhance the project's chances of success and minimize potential losses. The firm should not rely solely on the EMV but should integrate qualitative factors, such as strategic alignment and competitive landscape, into its decision-making process.
Answer Length
This is a comprehensive model answer for learning purposes and may exceed the word limit. In the exam, always adhere to the prescribed word count.