Hey guys -
I received insight that I will be asked a brain teaser very similar to the one below (numbers / %s made up) but I am stuck on how I would even go about solving. The person who told me said only one person has ever gotten the answer right and its all about how I would think about solving. I tried to explain it to the best of my knowledge below and would greatly appreciate your thoughts (feel free to PM if you prefer). Thanks in advance!
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You have a medical company that produces cholesterol medicine and is in the process of being FDA approved. There are five stages of approval and the likelihood of the drug getting passed through each stage is outlined below. The company has already passed stage 1 and has four left to go.
Stage 1 Stage 2 Stage 3 Stage 4 Stage 5
20% 40% 80% 60% 50%
Assumptions:
• You are given an upfront cost (call it $50mm for now)
• If the drug passes stage 5, the drug will be worth roughly $200mm
Question:
What is the minimum percentage increase that you would be willing to pay $100mm to increase your likelihood of passing stage 2? (i.e., it can’t be 100% and can’t be 40%)
---Message from WSO Below---
you probably have to times all the percentages together to find one percentage which represents the drug's overall chance of passing all the phases. then times that percentage by what it would be worth to find its actual value. subtract the upfront cost from that to get a net value. then just fool around with phase 2s pass percentage to see how it effects shit. keep increasing it until the NPV goes from negative to positive, where that happens shud b ur answer
Since the drug has already passed stage 1, there's a 9.6% chance it passes Stage 5 (.4.8.6*.5).
If it passes stage 5, the value of the project is $200M. If it doesn't pass stage 5, the value of the project is 0.
9.6% x 200M = 19.6M.
I don't know where to go from there... It doesn't look like a good project to me.
I might be way off, but the way I thought about it was this:
You stand to make $200M and have an upcront cost of $50M, leaving you with a potential profit of $150M
You are only concerned with the second stage for this problem. So I'd calculate the propbability of passing stages 3-5 as (.8.6.5=24%).
Stage 2 is worth (at max) 24% of your potential $150M profit or $36M.
Yea man, looks like a bogus question. To start, 50MM / 200M = 0.25 = 25% chance needed to get through the subsequent rounds for it to be a positive NPV project.
So then you need to see what the likelihood is of passing the last three rounds before you focus on round 2. (.8.6.5 = 0.24 = 24%) Even with a 100% likelihood of passing round 2 this is still a negative NPV project as 24%
.
They actually do this kind of valuation with real pre-revenue pharma companies. It's called risk-adjusted PV (RPV). Not sure how it works per say, but I'm sure someone can either help you or you can do some reading on it.
whiskey is on the right track with this one, but I can't remember any of that stuff. I'm sure there's a ton to read about valuing pre-rev pharma companies though.
How long do you expect to answer this question, because it might be something much easier if you don't have a lot of time.
i figure you just threw #s in there to be able to say the "type" of question it was instead of like literally asking for an answer. But if I'm not mistaken, those #s worked out to
Way I look at it is, getting past stage 2 means you still have stages 3, 4 and 5 left, which means you only have a 0.8 x 0.6 x0.5 = 0.24 chance of realizing $200 mil. Which means, after stage 2, you're left w/ a project that is worth $48 million.
Reword the problem like this...if you have a chance to pay $100 mil. to improve your odds of getting $48 million, how much % would you want to increase it? answer is, HELL NO I AIN'T PAYIN'!!!!
Guys, remember he said those number and %'s are made up. That's why you're all struggling with this. He is just looking for a method to solve a problem LIKE this one.
buddyfox has the right idea - use a decision tree and basically calculate the product of the probability of passing each stage in the future * payoff at end of 200 to be the expected value at each stage.
at stage 2: (40%80%60%50%) * 200 = 19.2 at stage 3: (80%60%*50%) * 200 = 48
The 50mm is an upfront cost and so is a sunk-cost and should be ignored in the calculations.
So the question can be recast as saying you are willing to pay
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