# Answer to Question #70992 in Finance for Nick Mango

Question #70992

Hypothetical drug-development program requires $200 million in out-of pocket

costs over a 10-year period during which no revenues are generated, and with

only a 5% probability of success. However, if the drug development is successful, it

is plausible to assume that it could generate a net income of $2 billion per year over

a 10-year period of exclusivity from years 11–20. The present value of this income

stream in year 10 is $12.3 billion (using a 10% cost of capital).

(a) Compute the expected return and standard deviation (over a 10-year period) of

this investment.

(b) Suppose we setup a megafund to fund 150 drug-development programs, with the

same amounts of investment and payoff as the one in part (a). Assuming that the

success or failure of each program is independent of each other, what is the probability

for the megafund to score three or more successes in the 150 drug-development

programs.

(c) Compute the expected return and standard deviation (over a 10-year period) of the

megafund.

costs over a 10-year period during which no revenues are generated, and with

only a 5% probability of success. However, if the drug development is successful, it

is plausible to assume that it could generate a net income of $2 billion per year over

a 10-year period of exclusivity from years 11–20. The present value of this income

stream in year 10 is $12.3 billion (using a 10% cost of capital).

(a) Compute the expected return and standard deviation (over a 10-year period) of

this investment.

(b) Suppose we setup a megafund to fund 150 drug-development programs, with the

same amounts of investment and payoff as the one in part (a). Assuming that the

success or failure of each program is independent of each other, what is the probability

for the megafund to score three or more successes in the 150 drug-development

programs.

(c) Compute the expected return and standard deviation (over a 10-year period) of the

megafund.

Expert's answer

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