as CEO of firm A, you and your management team face the decision of wether to undertake a $200 million R&D effort to create a new mega-medicine. your research scientists estimate that there is a 40 percent chance of successfully creating the drug. success means securing a worldwide patent worth $550 million (implying a net profit of $350 million). however firm B (your main rival) has just announced that it is spending $150 million to pursue development of the same medicine (by a scientific method completly independent of yours). you judge that B's chance of success is 30 percent. furthermore, if both firms are successful, they will split equally the available worldwide profits ($275 million each) based on separate patents.
given its vast financial resources, firm A is risk neutral. should firm A undertake the $200 million R&D effort? (use a decision tree to justify your answer)
now suppose that it is feasible for firm A to delay its R&d decision until after the results of B's R&D effort (success or failure) is known. is it advantageous for firm A to have this second move? (use a decision tree to justify your answer)
instead, suppose that firm A and firm B can form a joint venture to pursue either or both of their R&D programs. what is the expected profit of simultaneously pursuing both programs? hint: be sure to compute the probability that both efforts fail (in which case the firms' combined loss is 200 + 150 = $350 million) could the joint venture profitably pursue a single program?
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