Question

AbbVie Pharmaceuticals (headquartered in Lake Forest, IL) has commenced a $10 million R&D project to develop a new drug to treat a rare disease. So far, it has spent $6 million of the $10 million, and preliminary results are positive. If the additional $4 million is invested, the drug will certainly be completed and is expected to generate profit of $18 million in present value for AbbVie. Meanwhile, a research biologist at Illinois Tech has independently developed a treatment for the same disease. The scientist has offered to sell her invention to AbbVie for $2 million. Her drug would be just as effective as AbbVie’s drug, and would also generate profit of $18 million in present value.

a. Should AbbVie buy the drug for $2 million?

b. What is the most AbbVie should be willing to pay for the Illinois Tech researcher’s drug?

c. How would your answer change if the Illinois Tech biologist had developed her drug two years ago, before AbbVie started its own R&D project?

Answer 1

Solution

AbbVie Pharmaceuticals (headquartered in Lake Forest, IL) has commenced a $10 million R&D project to develop a new drug to treat a rare disease. So far, it has spent $6 million of the $10 million, and preliminary results are positive. If the additional $4 million is invested, the drug will certainly be completed and is expected to generate profit of $18 million in present value for AbbVie.

a) Abbive has $ 4 million still to spend to complete development of its drug;

Buying the northwestern invention for $2 million is a terrific baragain.

b) Abbive should spend up $ 4million for the northwestren researches drug; thats Abbive Own marginal cost of developing its own drug .The $6 million already spents is a sunk cost.

c) sunk costs aren't sunk untill you slink them. from the prespective of 2years ago , Abbive is choosing between buying the drug and spending $10 million to develop its own.

If Abbive can buy its for anything under $10 million it should do do.