As CEO of J&J, a huge pharmaceutical company, you and your management team face the decision of whether to undertake a $150 million R&D effort to create a new mega-medicine. Your research scientists estimate that there is a 35 percent chance of successfully creating the drug. Success means securing a worldwide patent worth $500 million (implying a net profit of $350 million). However, firm BigMed (your main rival) has just announced that it is spending $100 million to pursue the development of the same medicine (by a scientific method completely independent of yours). You judge that BigMed’s chance of success is 40 percent. Furthermore, if both firms are successful, they will split equally the available worldwide profits ($250 million each) based on separate patents. Assume that firms J&J and BigMed are risk neutral. Use decision trees and the expected profits criterion to justify your answer for the following problems. Should firm J&J undertake the R&D effort to create a new medicine? Suppose that firm J&J can wait for the results of BigMed's programme and then decide. Calculate the expected profits resulting from this decision. Would you recommend this course of action?
As CEO of J&J, a huge pharmaceutical company, you and your management team face the decision of whether to undertake a $150 million R&D effort to create a new mega-medicine. Your research scientists estimate that there is a 35 percent chance of successfully creating the drug. Success means securing a worldwide patent worth $500 million (implying a net profit of $350 million). However, firm BigMed (your main rival) has just announced that it is spending $100 million to pursue the development of the same medicine (by a scientific method completely independent of yours). You judge that BigMed’s chance of success is 40 percent. Furthermore, if both firms are successful, they will split equally the available worldwide profits ($250 million each) based on separate patents. Assume that firms J&J and BigMed are risk neutral. Use decision trees and the expected profits criterion to justify your answer for the following problems.
- Should firm J&J undertake the R&D effort to create a new medicine?
- Suppose that firm J&J can wait for the results of BigMed's programme and then decide. Calculate the expected profits resulting from this decision. Would you recommend this course of action?
![4. As CEO of J&J, a huge pharmaceutical company, you and your management team face the decision of
whether to undertake a $150 million R&D effort to create a new mega-medicine. Your research scientists
estimate that there is a 35 percent chance of successfully creating the drug. Success means securing a
worldwide patent worth $500 million (implying a net profit of $350 million). However, firm BigMed
(your main rival) has just announced that it is spending $100 million to pursue the development of the
same medicine (by a scientific method completely independent of yours). You judge that BigMed's
chance of success is 40 percent. Furthermore, if both firms are successful, they will split equally the
available worldwide profits ($250 million each) based on separate patents. Assume that firms J&J and
BigMed are risk neutral. Use decision trees and the expected profits criterion to justify your answer for
the following problems.
a) Should firm J&J undertake the R&D effort to create a new medicine?
b) Suppose that firm J&J can wait for the results of BigMed's programme and then decide. Calculate the
expected profits resulting from this decision. Would you recommend this course of action?](/v2/_next/image?url=https%3A%2F%2Fcontent.bartleby.com%2Fqna-images%2Fquestion%2F8923f717-3220-4668-9d8a-3492e94e7c7a%2F15604975-05f5-41ad-8ea8-ab0c92762097%2Fx0potx_processed.png&w=3840&q=75)
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