Analytical Framework for Examining the Value of Antibacterial Products. 3.2.1 Real Opportunity Cost of Capital

04/15/2014

The real opportunity cost of capital represents the rate of return (net of inflation) that the drug sponsor would otherwise be able to earn at the same risk level as the investment in the new antibacterial drug that has been selected.  The cost of capital rates used by the pharmaceutical sector reported in the literature range from a low of 9 percent to as high as 40 percent.  For example, in their most widely cited study, DiMasi et al (2004) use an 11 percent discount rate based (in part) on historic returns in the industry.

According to experts interviewed, the opportunity cost of capital varies significantly by drug sponsor-specific factors, such as new product candidate portfolio, size of company, type of company (pharmaceutical or biopharmaceutical), as well as other exogenous factors, such as economic and regulatory climate for drug development projects.  While large pharmaceutical companies use rates ranging from 9 percent to 13 percent, the rates used by small venture-capital backed pharmaceutical companies tend to be much higher ranging from 20 percent to as high as 70 percent.  On the other hand, the rates used by biopharmaceutical companies reportedly vary from 18 percent to 24 percent.

In the model, we use 11 percent as the average real opportunity cost of capital.  Because the parameter value heavily influences private ENPV outcomes, we assign a triangular probability distribution with a lower limit of 9 percent, an upper limit of 24 percent, and a likely point estimate of 11 percent for sensitivity analysis purposes.

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