Use the information below to answer the following question(s).
Below is a decision tree illustrating the R&D process for a new drug.

Let us assume that if the market is large, the payoff is lognormally distributed with a mean of $ 4,900 million and a standard deviation of $ 1,000 million; if the market is medium, the payoff is lognormally distributed with a mean of $2,500 million and a standard deviation of $500 million; and if the market is small, the payoff is normally distributed with a mean of $1,800 million and standard deviation of $200 million.

-What is the coefficient of variation obtained from the simulation results? [Hint: Choose the approximate value.]
A)1.587
B)1.126
C)2.015
D)1.890

Question

Use the information below to answer the following question(s).
Below is a decision tree illustrating the R&D process for a new drug.
  
Let us assume that if the market is large, the payoff is lognormally distributed with a mean of $ 4,900 million and a standard deviation of $ 1,000 million; if the market is medium, the payoff is lognormally distributed with a mean of $2,500 million and a standard deviation of $500 million; and if the market is small, the payoff is normally distributed with a mean of $1,800 million and standard deviation of $200 million.
 
-What is the coefficient of variation obtained from the simulation results? [Hint: Choose the approximate value.]
A)1.587 
B)1.126 
C)2.015 
D)1.890

Quizplus · Accepted Answer

Based on the decision tree and the simulation results, the best choice is to invest in the project if the market is medium (Option B) since the expected present value of the payoff (after discounting) is higher than the initial investment. The other options (A and C) have negative expected present values and are not profitable. Option D has a positive expected present value, but it has a high level of risk (high coefficient of variation), which may not be acceptable for the company's risk appetite.

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