Question

The news is constantly reporting on all of the various drugs under development for a successful vaccination for Covid19. Please use a decision tree/real option framework to analyze if our firm should invest $250 million a year in research and development in a search for a solution. Assumptions:

- a solution will be found by someone in exactly two year’s time (at t=2)

- there will only be one successful product approved (it will be winner takes all in that the successful firm will get a monopoly of this market)

- the world’s population is 8 billion people and everyone will be needing a vaccination

- the expected profit for each vaccination will be regulated (capped) at $10/person

- 100 firms begin working for a solution today and each has an equal probability of being successful

- each firm will only be working on one potential drug (i.e., no synergies inside a firm by working on more than one drug)

- each firm will be investing $250 million for each of the next two years (no firm will abandon the project during the period)

- a risk adjusted WACC of 30 percent is applicable for all of these firms

Should our firm decide to work for a solution to the Covid19?

Answer 1

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