TIM172A: MOT I: Homework 4: Decision Analysis

Reading: U&E, PDD, Fourth Edition, Chapter 3-5 (Pages 33-96); and class handouts.

"Simple it's not, I'm afraid you'll find, for a mind-maker-upper to make up his mind" - Dr. Seuss on Decision Making

Homework Problems

1. Research & Development. Jackson Pharmaceuticals Inc. is considering funding a research team to cure

Lyme's disease. Bill Mackenzie, executive VP of research, must ultimately make this decision. The

research program has a total price tag of $10M (million), and there is no guarantee that it will be

successful. In fact, Bill estimates only a 40% chance that they will find a cure. If the research team finds

a cure, Jackson Pharmaceuticals must then decide whether they wish to produce the drug themselves or

sell the license to a chemical lab for $40M revenue. If they produce the product themselves and

production goes smoothly, they forecast a revenue of $60M. However, refitting one of their production

facilities is not without risk. There is a 30% chance of production troubles, in which case they would

earn only $20M revenue.

What should Bill McKenzie do? (Result: Expected Monetary Value or payoff from a successful R&D

project = $9.2 M)

How do you think the probability, cost, and revenue information used in this analysis were obtained?

2. Should Pharma C, Inc. invest in product development of Compound X? If a cure can be developed

for Some Horrible Disease (SHD), it would be beneficial to humankind and yield a profit of $500M.

Our initial research indicates a 25% chance that a Compound X will be effective against SHD. However,

confirmation of efficacy will require an additional $25M investment in R&D. Furthermore, even if

Compound X is proven effective, an additional $25M will be required for the clinical trials required to

get it approved for human use. It is estimated that there is a 40% chance that these trials will reveal

serious side effects and approval will be denied.

As SHD's project director you are concerned with 2 principal issues. First, should you pursue the

commercial development of Compound X? Second, if you do pursue development, what value should

you place on the project when comparing it to competing projects?

Perform a sensitivity analysis on your results.