Part 2 A small biotech company has developed a burn treatment with commercial po

Question

Part 2 A small biotech company has developed a burn treatment with commercial potential. The company has to decide whether to (1) produce the new compound itself or (2) sell the rights to the compound to a large drug company. The payoffs from each of these courses of action depend on whether or not the treatment is approved by the Food and Drug Administration (FDA), the regulatory body of the United States that approves all new drug treatments. The company must make its decision before the FDA decides. Here are the payoffs the drug company can expect to get under the options it faces: Probabil 0.20 0.80 Decision Sell the $10 $2 FDA approves FDA does not $60 10 (payoffs are in millions of dollars) Draw a decision tree reflecting the decisions the company can make and the payoffs from all possible outcomes Make sure to carefully distinguish between the chance nodes and decision nodes in the tree. Assuming that the firm is a risk-neutral decision maker, use backwards induction to determine whether the firm wants to sell the rights or not. Explain each step? 7. 8. Suppose that Amanda, the head of new product development at the biotech company, is in charge of making the decision on whether or not to sell the rights to the burn treatment. She has a base salary of $50,000 per year and in addition to this she earns a bonus of 0.1% of the firm's profits. Amanda's receives utility of u()-101, where I is total salary. 9. Calculate the utility Amanda receives from each of the four possible outcomes. 10. Draw a decision tree reflecting the decisions Amanda can make and the utilities she receives from all possible outcomes. Make sure to carefully distinguish between the chance nodes and decision nodes in the tree. 11. Assuming that Amanda wants to maximize her expected utility, use backwards induction to determine whether she wants to sell the rights or not. Explain each step

Explanation / Answer

Decision - Sell the rights - FDA Approves (0.2) (10)

FDA Doesn't approve ( 0.8) (2)

  

Produce - FDA Approves (0.2) (60)

FDA Doesn't approve ( 0.8) (-10)

8) If Sell, Expected payoff = 0.8*2+0.2*10 =3.6

If produce, Expected payoff= 0.8*(-10)+0.2*(60)=4

Hence, it will not want to sell the rights since expected payoff is lower

Related Questions

Navigate

• Browse (All)
• Browse P
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.