Farma Inc. is working on the development of a new drug to combat Fingulesa. It h
ID: 1231601 • Letter: F
Question
Farma Inc. is working on the development of a new drug to combat Fingulesa. It has identified two strategies to pursue. Strategy one has a probability of success of 40% and strategy 2 has a probability of success of 60%. Strategy one costs $20,000 per month to pursue and strategy two costs $35,000 per month to pursue. Farma estimates it will take 6 months before it knows if a strategy will work. If either strategy works, Farma estimates it will reap $500,000 in additional revenue.a. Ignoring the discount rate, calculate the expected net benefits under each strategy. If only one strategy will be pursued, which one should it be? Why?
b. Now, consider the possibility of pursuing both strategies at the same time. How does that affect the probability of success? (The strategies are independent). What is the expected net benefit if both strategies are pursued at the same time?
Explanation / Answer
A. Strategy #1 The net benefit will be $380,000. (500,000 - 120,000 = 380,000) Strategy #2 The net benefit will be $290,000. (500,000 - 210,000 = 290,000) Strategy #2 should be pursued since the probability of it's success is higher than strategy #1 (and greater than 50%). Even though the net benefit is lower in Strategy #2 ($90,000 lower) most companies will look for a safer project with a higher probability for success since the net benefits are both positive/profitable. B. The probability for success of pursuing both strategies would be 24%. Probability (Strategy #1) * (Strategy #2) The expected net benefit would be $170,000. (500,000 - 120,000 - 210,000). Which is lower than if each event was pursued instead of the other and the probability is much lower so I would advised against this.
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