I’m reading an article on a hypothetical drug that’s coming to market in the next 6-7 years. The value of the drug is around $1 billion but it has a 35% chance of passing Phase I and II trials. As a result, the drug has a valuation of 350 million (i.e. $1B x 35%).
How does this make any sense? How can you use probabilities to value a drug here based on its probability of success?
I’ve read this in other areas too e.g. the probability of a product failure is 23% so if the product costs $100, the warranty should cost $23 (i.e. $100 x 23%).
I’ve tried to believe that this can be quantified e.g. for every 100 products we sell, 23 of them will fail (as percentages are out of 100) so we should charge a warranty of $23 since we will spend $2300 on fixing 100 products if those costs are not made back.
However, in the case of the drug pipeline, I don’t understand how this works. As far as I can deduce, for every 100 times you push the drug through, only 35 attempts will be successful. So, the drug will make you $350M for every time (on average) it passes a test. I don’t understand what the $350M means in this case.
Any help to wrap my head around this concept would be appreciated!