Business Finance
MGT 492 University of Toronto Strategic Management Problem Set Powerpoint

MGT 492

University of Toronto


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Final Answer

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Introduction to Strategic Management
Problem Set 2

Question #1
R-Nucleo signs a contract with Pharma-M. R-Nucleo will have to build a new facility with highly
specialized equipment and carry out drug testing for a new drug developed by Pharma-M. The total cost of
the facility (including operative costs) is $7 million. The resale value of the facility is $3 million. According to
the contract, Pharma-M will have to pay R-Nucleo a total of $12 million, but payments will only start after
the initial investment has been made.
a. Compute the quasi-rent implied by this contract [Hint: Compute R-Nucleo’s income if the contract
goes smoothly. Then, compute R-Nucleo’s income if the plant is built, but the contractual relationship
is broken before Pharma-M makes any payment. Finally, take the difference between the two.]
b. Assume that, once R-Nucleo has built the facility, some unforeseen contingency (i.e. not specified
by the contract) occurs, so that Pharma-M has the option to either leave the contractual relationship, or
demand a renegotiation of the $12m payment. What is the minimum amount that Pharma-M can
expect to pay to R-Nucleo, and still induce R-Nucleo to stay in the contract?

Answer #1
A) Income if contract goes smoothly = $12 million - $7 million = $5 million
Income if pl...

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