Instructions

Read the following case - let and answer the question that follow

Krishna Reddy was the head of a pharmaceutical company that was trying to develop a new product. Reddy, along with his friend Prabhakar Rao, assessed that such products had mixed success. Reddy and Rao realized that if a new product (a drug) was a success, it may result in sales of 100 crores but if it is unsuccessful, the sales may be only 20 crores. They further assessed that a new drug was likely to be successful 50% of times. Cost of launching the new drug was likely to be 50 crores.

Question 1

How much profit can the company expect to earn if it launches the new drug(suppose there are no additional costs)?

Solution

The total cost incurred =50 Cr

The earning = 100$$\times\ $$1/2 + 20$$\times\ $$1/2=60 Cr.

Hence the net profit=10 Cr.

Question 2

Now, Reddy and Rao were in a quandary whether the company should go ahead and market the drug. They
contacted Raj Adduri, a common friend for advice. Adduri was of the opinion that given the risky nature of the launch, it may be a better idea to test the market. Rao and Reddy realized test marketing would cost 10
crores. Adduri told them the previous test marketing results have been favourable 70% of times and success rate of products favourably tested was 80%. Further, when test marketing results were unfavourable; the products have been successful 30% of the times.

How much profit can the company expect to make if the product is launched after favourable test marketing results(assume there are no additional costs)?

Solution

Total Cost = 50+10=60 Cr

Chances of success after favorable results= 80%

Expected return = 100$$\times\ $$0.8+ 20$$\times\ $$0.2=84Cr

Expected profit= 84-60=24Cr

Question 3

Now, Reddy and Rao were in a quandary whether the company should go ahead and market the drug. They
contacted Raj Adduri, a common friend for advice. Adduri was of the opinion that given the risky nature of launch, it may be a better idea to test the market. Rao and Reddy realized test marketing would cost 10
crores. Adduri told them the previous test marketing results have been favorable 70% of times and success
rate of products favorably tested was 80%.Further, when test marketing results were unfavorable; the products have been successful 30% of the times.

What is the probability of product failure if Reddy and Rao decide to test market it?

Solution

Results have been favourable 70% of times and success rate of products favourably tested was 80%.

Further, when test marketing results were unfavourable i.e. 30 %; the products have been successful 30% of the times.

The probability of product failure if Reddy and Rao decide to test market it= 7/10$$\times\ $$2/10 + 3/10$$\times\ $$7/10=35/100

=0.35

Question 4

Now, Reddy and Rao were in a quandary whether the company should go ahead and market the drug. They
contacted Raj Adduri, a common friend for advice. Adduri was of the opinion that given the risky nature of launch, it may be a better idea to test the market. Rao and Reddy realized test marketing would cost 10
crores. Adduri told them the previous test marketing results have been favorable 70% of times and success
rate of products favorably tested was 80%.Further, when test marketing results were unfavorable; the products have been successful 30% of the times.

If Rao and Reddy decide to launch the product despite unfavourable test marketing, how much profit can the company expect to earn?

Solution

After testing the market the total cost incurred= 50+10=60Cr.

The product will be a success 30% of times after the marketing test is unfavourable. So the probability of success is 0.3.

The probability of failure= 0.7.

The expected return is = 20 $$\times\ $$ 0.7+100$$\times\$$0.3 = 44Cr.

Total profit= 44-60 Cr=-16Cr.