Reference no: EM132781775

Question - Community Pharmaceuticals is currently developing a COVID-19 medication. Community invested hundreds of millions of dollars each year in research. Allocating those funds among various projects, however, was a rather involved and inexact process. At a company as large as Community, there was never a single method by which projects were approved or money distributed.

Studies showed that, on the average, it took 2 years and $200 million to bring a new drug to market. Final approval on research was not made, however, until the head of research met later with a committee of scientific advisors. Each potential program was extensively reviewed, analyzed on the basis of the likelihood of success, the existing market, competition, potential safety problems, manufacturing feasibility, and distribution before the decision was made whether to allocate funds for continued experimentation.

A leading research scientist at Community has found that a possible medication that may cure Covid-19. He has presented his research to the committee. The preliminary results showed that this compound was likely to be successful. Community had built a research team dedicated to alleviating human suffering. In fact, Community scientists were among the best paid in the industry and were given great latitude to pursue intriguing leads. Moreover, they were inspired to think of their work as a quest to alleviate human disease and suffering world-wide. Community employees found the words inspirational of the son of the founder and former chairman: "We try never to forget that medicine is for the people. It is not for the profits. The profits follow, and if we have remembered that they have never failed to appear. The better we have remembered it, the larger they have been." These words formed the basis of Community's overall corporate philosophy.

The problem is that this drug was very expensive to research and additionally had high costs of distribution. Even though it had a high probability of success, it was still a gamble. A decision to proceed would not be without risks.

1) It would take 18 months of research to develop. This would cost $500 million.

2) Community Pharmaceutical used a discount rate of 6%.

3) It would have a life of 15 years.

4) Outflows for manufacturing and distribution would be $7 million per year

5) Inflows from revenue would be $15 million per years

6) The Internal Rate of Return was a negative 11%

7) The Net Present Value was a positive $403 million

REQUIREMENTS -

1) A decision to make capital investments is based on more than if it is financially sound. Discuss the pros and cons of the risks associated with the specific assumptions noted below?

a. Uncertainty of discount rate (Cost of Capital) Give examples of how and why the discount rate may change over the 15 years. What is the impact to NPV is the discount rate is too low? Or too high? What should be included in determining the risk factors?

b. Uncertainty of projected cash flows - give examples of how and why the projected cash flows may be too high or too low. What can cause the projections to be off?

c. What are the "intangible benefits"? Can they be given an estimated value?

2) Discuss the liability and reputation risks associated with failure or side effects of the medication. Give examples if the drug is successful and if it is a failure.

3) Discuss the internal (financial losses, employee morale, investor sentiment, marketing advantages) effects in their decision to proceed with research?

4) Discuss external factors such as economic (future profit or loss), social (reputation), legal (liability), and environmental. Give examples for each factor assuming they continue with the research and it is successful.