Assignment: Decision Analysis

Note: Decision Trees must be typed/drawn (in Word, Excel etc.) or neatly handwritten/scanned and uploaded to D2L.

Scenario: LMD Pharmaceuticals has just developed a new drug for combating obesity. During the preliminary drug trials, it was also found to be effective in lowering cholesterol. LMD must now submit the drug for FDA approvals. They must decide if they will submit the drug for approval as both obesity & cholesterol (together), or for obesity only. For the obesity only option, there is a 0.20 probability of approval. For obesity & cholesterol, there is a 0.10 probability of approval. The estimated net present value of the profits for an obesity only drug is $480 million if it is approved and -$30 million if it is not approved (cost of development, clinical trials etc.). The estimated net present value of the profits for an obesity and cholesterol drug is $680 million if it is approved.

If the FDA does not approve for both obesity & cholesterol, LMD can choose to sell the rights to an outside firm for further development to recoup some of the estimated development losses, resulting in an estimated net present value of $5 million, or it can re-submit the drug for obesity only approval. It has been determined that the resubmission for obesity has a 0.18 probability of approval and a 0.82 probability it will not be approved. If approved for obesity only, the estimated net present value of the profits is $400 million, and -$80 million if it is not approved (total costs of approval processes).

a) For the above scenario, set up and solve the associated decision tree to portray the decision strategy with the highest expected net profit. Below the tree, state the overall decision strategy determined and the expected net profit.

b) Provide the risk profile (table) of the strategy you specified in part a.

c) Determine the EVPI for assessing the probability of approval for both obesity & cholesterol prior to submitting to the FDA. (show calculations/steps taken)