Construct a sensitivity analysis of the value of the pharmaceutical R&D project described in Figure 22.8. What input assumptions are most critical for the NPV of the project? Be sure to check the inputs to valuing the real option to invest at year 2.

  

(Reference Figure 22.8)

  

     

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Call Phase Il tials, 2 years Phase I trials and prelaunch, 3 years option PVat launch, year 5 (Forecast = $350) Succeed Succeed 44% 80% Invest $130 at year2 Invest 18? 56% 20% Fail PV = 0 Fail PV = 0 Underlying asset D FIGURE 22.8 The decision tree from Figure 10.7 recast as a real option. If phase Il trials are successful, the company has a real call option to invest $130 million. If the option is exercised, the company gets an 80% chance of launching an approved drug. The PV of the drug, which is forecasted at $350 million in year 5, is the underlying asset for the call option. Call Phase Il tials, 2 years Phase I trials and prelaunch, 3 years option PVat launch, year 5 (Forecast = $350) Succeed Succeed 44% 80% Invest $130 at year2 Invest 18? 56% 20% Fail PV = 0 Fail PV = 0 Underlying asset D FIGURE 22.8 The decision tree from Figure 10.7 recast as a real option. If phase Il trials are successful, the company has a real call option to invest $130 million. If the option is exercised, the company gets an 80% chance of launching an approved drug. The PV of the drug, which is forecasted at $350 million in year 5, is the underlying asset for the call option.

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