Gamma Pharmaceuticals is using the stage-gate process to develop their latest new innovative drug. At this point in time, the stage-gate process is before the Development stage, with Commercialization as the only remaining stage before . There is a Go/No-go gate between Development and Commercialization stages.

The following information is based on best current estimates:

The Development stage will cost $ 8 million. The probability of success at the end of this stage is 0.5. However, in case of failure (0.5 probability), the project will be stopped before the Commercialization stage, so there will be no further cost outflows (nor any inflows).

The Commercialization stage will cost $ 10 million. The probability of a successful outcome is 0.75. In case of success, the product will be launched, and will generate a stream of profits with an expected present value of $30 million. However, if the outcome is failure (with 0.25 probability), the project is stopped, the product is not launched, and no further cost is incurred, but the plant and machinery purchased for commercialization will be sold for $10 million.

(A) What is the Expected Present Value of this new product development project, evaluated before the decision is made to start the Development stage? (6 points)

(B) Gamma has recently adopted the open innovation model. They have learned that if the new drug does not make it through to the Commercialization stage after development, there is another pharmaceutical company that is willing to pay Gamma $ 7 million for the technology. What is the Expected Present Value in this case? (Everything else remains unchanged from Part (A) (6 points)

Answer rating: 100% (QA)

A The expected present value of the new product development ... View the full answer