Can someone please offer an explanation and solution to this problem?
The question has been adapted for this forum. It originally comes from a McKinsey case.
Below is a description of expected probability of success, by stage, in a biotech firm's R&D pipeline.
The R&D of a drug has several phases (1-4). As a drug goes through each stage, there is a probability of it suceeding:-
Phase 1 ---(70%)---> Phase 2 ---(40%)---> Phase 3 ---(50%)---> Phase 4 ---(90%)---> successful marketing & sales
This firm believes that the likelihood of success of its primary drug candidate can be improved by investing an additional $150 million in a larger Phase 2 trial. The hope is that this investment would raise the success rate in Phase 2, meaning that more candidate drugs successfully make it to Phase 3 and beyond. By how much would the Phase 2 success rate need to increase in order for this investment to break even?
Assume that if the drug is successfully marketed and sold, it would be worth $1.2 billion (that is, the present value of all future profits from selling the drug is $1.2 billion).