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Hypothetical drug-development program requires $200 million in out-of pocket
costs over a 10-year period during which no revenues are generated, and with
only a 5% probability of success. However, if the drug development is successful, it
is plausible to assume that it could generate a net income of $2 billion per year over
a 10-year period of exclusivity from years 11–20. The present value of this income
stream in year 10 is $12.3 billion (using a 10% cost of capital).
(a) Compute the expected return and standard deviation (over a 10-year period) of
this investment.
(b) Suppose we setup a megafund to fund 150 drug-development programs, with the
same amounts of investment and payoff as the one in part (a). Assuming that the
success or failure of each program is independent of each other, what is the probability
for the megafund to score three or more successes in the 150 drug-development
programs.
(c) Compute the expected return and standard deviation (over a 10-year period) of the
megafund.

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