Hi,

the case seems like a relatively straightforward case of expected returns.

You know that the outlay of R&D cost $150m is real money. Therefore that money has the same value, as the payoff you get from drugs that make it through all phases (because that is also real without any discount for expectation)

You need to go backwards from the expected payoffs, and estimate the value of all drugs in trial in the various phases (of which you know some are not going to make it.)

In Market: 1.2b

In Phase 4: 1.2b / 90% = 1.33b

In Phase 3: 1.33b/50% = 2.66b

In Phase 2: 2.66b/40% = 6.66b

In Phase 1: 6.66b/70%= 9.5b

Now, the value of the drugs in the first phase does not change. However, we need to break even, meaning we need to make back the $150 investment in our 'in Market' phase. Therefore, the new value for In Market is: 1.35b.

Applying the same backwards logic results in:

In Market: 1.35b

In Phase 4: 1.35b/90%= 1.5b

In Phase 3: 1.5b/50%= 3b

In Phase 2: 3b/40% = 7.5b

In Phase 1: 7.5b/70% = 10.7b

As I mentioned above, the value of 10.7b is irelevant, as this would imply that we give more drugs into the development funnel. However, the question is to broaden the funnel, i.e. how do we get with the potential market of 9.5b (if all drugs tested became a success through all phases) to 1.35b (what we need to recoup investment). We are given the fact that the improvement happens in Phase 2, so we solve for the formula:

9.5b*x = 7.5b, x=0.79

Therefore, the answer shold be that the success rate in phase 2 would need to increase from 40% to 79%, an increase of almost 100%, to recoup the $150m investment.

On a sidenote, maybe worth mentioning that the drugs that make it through all phases have an NPV of 1.2b. That means it can take quite a long time to recoup the money (at 5% interest rate, it is about 20 years worth of returns, of around 60m each year. It depends whether the company has the same risk appetite for return on their investment cost, i.e. is the NPV value of the last stage a valid measure of the return. I assume it is in this case scenario, but in real life it may differ).

Cheers,

Hi,

the case seems like a relatively straightforward case of expected returns.

You know that the outlay of R&D cost $150m is real money. Therefore that money has the same value, as the payoff you get from drugs that make it through all phases (because that is also real without any discount for expectation)

You need to go backwards from the expected payoffs, and estimate the value of all drugs in trial in the various phases (of which you know some are not going to make it.)

In Market: 1.2b

In Phase 4: 1.2b / 90% = 1.33b

In Phase 3: 1.33b/50% = 2.66b

In Phase 2: 2.66b/40% = 6.66b

In Phase 1: 6.66b/70%= 9.5b

Now, the value of the drugs in the first phase does not change. However, we need to break even, meaning we need to make back the $150 investment in our 'in Market' phase. Therefore, the new value for In Market is: 1.35b.

Applying the same backwards logic results in:

In Market: 1.35b

In Phase 4: 1.35b/90%= 1.5b

In Phase 3: 1.5b/50%= 3b

In Phase 2: 3b/40% = 7.5b

In Phase 1: 7.5b/70% = 10.7b

As I mentioned above, the value of 10.7b is irelevant, as this would imply that we give more drugs into the development funnel. However, the question is to broaden the funnel, i.e. how do we get with the potential market of 9.5b (if all drugs tested became a success through all phases) to 1.35b (what we need to recoup investment). We are given the fact that the improvement happens in Phase 2, so we solve for the formula:

9.5b*x = 7.5b, x=0.79

Therefore, the answer shold be that the success rate in phase 2 would need to increase from 40% to 79%, an increase of almost 100%, to recoup the $150m investment.

On a sidenote, maybe worth mentioning that the drugs that make it through all phases have an NPV of 1.2b. That means it can take quite a long time to recoup the money (at 5% interest rate, it is about 20 years worth of returns, of around 60m each year. It depends whether the company has the same risk appetite for return on their investment cost, i.e. is the NPV value of the last stage a valid measure of the return. I assume it is in this case scenario, but in real life it may differ).

Cheers,