Drugco has just begun Phase III trials for Newdrug. For simplicity, we assume that we are sure

Question:

Drugco has just begun Phase III trials for Newdrug. For simplicity, we assume that we are sure the drug has no side effects, so all that matters for FDA approval is its efficacy.

Efficacy is distributed E ~ U[0, 1] and will be learned during three years of Phase III trials. The NPV of the drug after three years is $1B * E. The discount rate is equal to the riskfree rate of 5 percent per year. The total cost of R&D is $100M and must be paid at the beginning of development.

(a) Draw an event tree for the Newdrug project.

(b) What is the NPV of Newdrug if efficacy is set equal to its expected value?

(c) Use Monte Carlo simulation to solve for the NPV of the Newdrug project.

(d) On average, will the answer to part (b) be different than the answer to part (c)?


Monte Carlo simulation
Monte Carlo simulation is a technique used to understand the impact of risk and uncertainty in financial, project management, cost, and other forecasting models. A Monte Carlo simulator helps one visualize most or all of the potential outcomes to...
Discount Rate
Depending upon the context, the discount rate has two different definitions and usages. First, the discount rate refers to the interest rate charged to the commercial banks and other financial institutions for the loans they take from the Federal...
Fantastic news! We've Found the answer you've been seeking!

Step by Step Answer:

Related Book For  book-img-for-question
Question Posted: