The medication industry has at least two types of firms

#3923
The medication industry has at least two types of firms. The first type is biotechnology
companies that focus their efforts on research and development (R&D) of new drugs. The
second type is pharmaceutical companies that also engage in developing new drugs, but spend
considerable efforts in the production, supply, and marketing of drugs.Suppose pharmaceutical
company ABC invests $500 million in R&D for the purpose of finding a vaccine for malaria. The
company estimates the probability of success at 10% over a five-year period. If a vaccine is
successfully developed, the estimated benefits in terms of future cash flows to the company will
be in the range of $10 billion to $20 billion.Pharmaceutical company XYZ also invests $500
million, but directs the funds to be invested in the equity' of publicly traded biotechnology (inns
that are all in the search for a malaria vaccine. Suppose that XYZ invests $50 million in each of
10 such biotechnology firms. In return, XYZ receives approximately 10% of the common equity'
in each of these firms. XYZ accounts for these investments on a “mark-to-market” basis
(meaning that changes in the biotechnology)' firms’ stock prices are reflected in XYZ’s assets
and income).Required:a. How should ABC and XYZ account for each of their $500 million
investments? Should they be capitalized as assets or expensed?b. Suppose ABC successfully
discovers a vaccine for malaria. How should it account for this discovery? If ABC were
unsuccessful, how should the company account for this outcome?c. Independent of (b),
suppose one of the companies in which XYZ has an investment discovers a malaria vaccine,
and the value of XYZ’s investment increases to $2 billion. How should XYZ account for this
outcome? Suppose the biotechnology company is unsuccessful and XYZ’s investment
becomes worthless. How should XYZ account for this outcome?d. Using the following table,
quantify the amount of revenue or income that would be recognized by ABC and XYZ in case of
success or failure.e. Comment on the differences between ABC and XYZ that you observe from
part (d).View Solution:
The medication industry has at least two types of firms

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