Contemporary Engineering Economics 6th Edition by Chan Park

تمرين 20

GlaxoSmithKline is a world leading research-based pharmaceutical company with a powerful combination of skills and resources that provides a platform for delivering strong growth in today's rapidly changing healthcare environment. GlaxoSmithKline's mission is to improve the quality of human life by enabling people to do more, feel better and live longer. Headquartered in the UK and with operations based in the US, the new company is one of the industry leaders, with an estimated seven per cent of the world's pharmaceutical market.
GlaxoSmithKline intends to continue developing innovative and cost-effective solutions in prevention, diagnosis and drug therapy to the ultimate benefit of patients. Keeping with its history of product development, GlaxoSmithKline announced recently that it has received FDA clearance for its Elecsys proBNP (pro-B-type natriuretic peptide) assay, the first fully automated test for use in the diagnosis of congestive heart failure (CHF). Now, laboratories can have results ready to report to physicians in as few as 18 minutes, using an automated platform that reduces technologist time and minimizes human errors.
GlaxoSmithKline now believes that it has the possibility to start a new project based on its Elecsys proBNP research, which could result in a test for the diagnosis of hardening of the arteries. No such test currently exists and GlaxoSmithKline believes the successful development of such a product would result in great financial reward.
Research Phase: The Company will hire 10 scientists and will pay each $80,000/year. Also there is an overhead cost of $160,000/year. The project requires a $3M initial equipment investment for the research phase, which will take about 4 years. This equipment will be depreciated with the straight-line method over 4 years. In the research phase there will be a cost of $500,000, $400,000, $400,000, $400,000 respectively for material cost each year.
Development Phase: In year 5 GlaxoSmith-Kline can pursue approval from appropriate agencies. This development phase will require 4 scientists at the previous pay level. The development phase will require the same equipment and also new equipment is required for development which costs $2M. This equipment is depreciated by the straight-line method over 4 years. Assume both sets of equipment will have no salvage value after they're fully depreciated. During the 4-year development phase initial overhead cost is $1M/ year for legal and lobbying fees. The material cost for development phase will be $350,000 for each year.
Manufacturing Phase: The research anddevelopment phases will give GlaxoSmithKline the opportunity to implement the new product in year 9. Manufacturing phase requires a $I00M equipment and machine investment which is to be depreciated according to the straight-line method over 10 years. (Once again, assume a zero salvage value of the assets.) Also, for marketing and distribution GlaxoSmithKline will spend $4M except for the first year, which is $10M. Labor cost in this phase will be $1M. The overhead, which will also include management, legal costs, will be $8M for each year. GlaxoSmithKline expects revenue of $50M/year for the foreseeable future.
Note that all cash flow figures above represent expected values. The risk free rate is known to be 6%, and the risk-adjusted discount rate is 12%. The firm's income tax rate is 40%. At this point, the firm has no clear idea on the volatility of the project return, even though its stock volatility is known to be around 15%. Formulate GlaxoSmithKline's decision process using the compound option framework, and then determine the desired level of project return volatility at minimum that allows the firm to initiate the research phase.