McKinsey Sample Case - Logic Question...

case math Math problem McKinsey Value Chain
Recent activity on Apr 11, 2017
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Anonymous A asked on Jan 15, 2017

In the quant section of this case, why isn't the correct answer 28.93 percentage points (increasing Phase II success from 40% to 68.93...% - and therefore the value of a product at Phase III from $540M to $607.5M)? That answer would result in a final likely value of $1.35B - which breaks even because it is $150M higher than the current likely final value... and the investment cost is $150M (isn't that the definition of breakeven?).

The answer key assumes that the measure of the $150M investement is the value it adds AT Phase III - and that the $150M should therefore be added to the Phase III value as deduced from the final value of $1.2B. The problem is that using the logic articulated in the answer key would result in a final AT MARKET value of $1.53B - which is significantly higher than the $1.35M that I'm thinking really represents a breakeven proposition.

Any clarifying advice would be helpful. Send me your wisdom!

Thanks! :)

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Anonymous replied on Apr 11, 2017

Hi there,

Let me chime in here. First, try to think of this problem in terms of the expected value of the candidate drug:

  • Expected Value = Likelihood of success * Present Value (in case of success)

Second, with this framework in mind, consider two scenarios: (1) Current likelihood of success; (2) Increased likelihood of success.

  1. In this scenario, we have: Expected Value = 70% * 40% * 50% * 90% * $1.2bn Expected Value = 12.6% * $1.2bn = ~$0.15bn => this is your baseline and the $150mn investment in Phase II has to be added to that. Thus, to breakeven, the expected value after the investment has to equal ~$300mn
  2. In this scenario, let's use "x" for the Phase II Likelihood of Success : Expected Value = $0.30bn = 70% * x * 50% * 90% * $1.2bn $0.30bn / $0.38 = x and, thus, x = ~80%

This means that, for the investment to break even, the likelihood of success in phase II would have to equal ~80%, a 40 p.p. increase from the current scenario.

Let me know if you have further questions.



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