Introduction
This paper presents a case study of a pharmaceutical firm that intends to develop a new medication. A decision tree will be used to analyze possible decisions. Furthermore, it uses decision probabilities together with outcome rates in modeling the intricate situation. Finally, “rolling back the tree” approach will be used to understand whether testing of the new medication will help to improve the firm’s decision making or no.
Stage One
The company invested $1 million in developing a new medication.
Stage Two
The firm plans to invest $2million capital in developing the new medication.
Compare Stage One and Two and Debate Whether Testing Improves the Company’s Decision-Making Ability
At the first stage, the firm can test the new remedy. The firm will invest $250,000 in the test. The firm can also develop the new medicine without testing it. There are higher chances that the new medication will successfully pass the test. Indicatively, the firm should test their new product owing to the possibilities of developing the new dose. Expenses associated with development of a new remedy include capital and medication testing costs (Bazerman & Moore, 2009). This amounts to $1,250,000. The firm will obtain the revenue of $5 million. The profit anticipated in this scenario is $3,750,000. This is obtained by deducting the expenses from the revenue.
The final development of a new medication may still present challenges even if the tests are successful. This is indicated by the 10% likelihood that the medicine may fail after the successful testing. Indicatively, the firm will not obtain the revenue. In this scenario, the firm loses invested capital together with the costs incurred in medication testing. This will amount to $1,250,000. The prospects that tests of the new medication might be fruitless are 20%. The firm may not obtain the anticipated revenue (Drury, 2006). Expenses associated with the venture are $1,250,000. This includes capital and medication analysis cost. The firm loses all the investment costs amounting to $1,250,000.
The firm can also skip testing their new medication. This reduces the expenses associated with drug testing. Expenses incurred while developing the new prescription amounts to $1,000,000. There are bigger prospects that development of a new medication may be successful even without testing. Successful development of a new medication enables the firm to obtain the revenue. In this scenario, the firm makes a profit of $4 million (Drury, 2006). There are also possibilities that the firm may not develop a new medication successfully. This is indicated by the probability of 28%. Eventually, the firm will not get revenue. The firm will lose $1 million invested in the project.
At the second stage, the firm can decide to test the new remedy using $250,000. The new medication has a very high potential of passing the tests. Successful testing of the new medication is crucial for its development. There are higher prospects that developing a new medication is tenable (Grünig, Clark & Kühn, 2009). In this scenario, the pharmaceutical firm will receive the revenue. The firm will make a profit of $2,750,000 from the venture. This is obtained by deducting the expenses from the revenue.
The firm may not obtain the revenue even when the medical tests are successful. There are slimmer chances (10%) that the firm may develop a new medication, thus failing to obtain the revenue. Therefore, the firm will incur $2,250,000 losses. Evidently, there are prospects that tests of a new medication may fail. In this case, the firm will not obtain the revenue. The firm will incur $2,250,000 losses. The pharmaceutical firm may also decide that their drug will not be subjected to the laboratory testing. In this scenario, the firm cuts down the expenses associated with developing a new medication. Indeed, the firm will incur only the $2million capital to complete the process. Furthermore, there are higher chances (72%) that the newly developed medication will be successful. If this is the case, the firm will obtain the standard revenue. Therefore, the total profit the firm will make under this arrangement is $3 million. This is obtained by deducting the expenses from the revenue. Conversely, if the firm’s attempt to develop the new medication fails as indicated by the (28%) probability, it will bring enormous losses. The losses will be unavoidable because $2million has been invested and the company failed to make the revenue.
From the ongoing discussions, the best option would be to develop the drug using stage one (Tang, 2004). It is evident that it will be the most beneficial for the pharmaceutical firm to develop the new drug without conducting tests in phase one.
References
Bazerman, M. H., & Moore, D. A. (2009). Judgment in Managerial Decision Making, 7th Ed. New Jersey, NJ: John Wiley & Sons, Inc.
Drury, C. (2006). Management accounting for business. London: Thomson Learning.
Grünig, R., Clark, A., & Kühn, R. (2009). Successful decision-making: A systematic approach to complex problems. Dordrecht, Netherlands: Springer.
Tang, S. L. (2004). Quantitative techniques for decision making in construction. Hong Kong: Hong Kong University Press.